Stop calling it a ‘fiscal cliff’

 

You’ve seen the scary headlines warning of an economic disaster heading our way. You’ve heard the overheated rhetoric, and seen fiscal countdown clocks, including one on this website.

It’s hogwash: The U.S. economy will not go over a “fiscal cliff” on Jan. 1, as we’ve been led to believe.

In truth, nothing much will happen to the economy on Jan. 1 or Jan. 2 or Jan. 3, despite the expiration of tax cuts and the automatic reductions in federal spending. For almost all of us, the first week of the new year will be much like the 52nd week of the old one.

The fiscal cliff is a misleading metaphor. The laws will change on that day, it’s true, but the impact will be spread out over many, many months. In fact, the effects are already being felt, particularly in financial markets. Businesses, investors, workers and consumers have begun to prepare for the changes, and that’s caused the economy to slow a bit already.

It’s not a Niagara Falls, with billions of gallons going over a cliff. It’s more like a bathtub slowly filling up. And, on Jan. 1, it’s going to spill over the edge. Eventually, it will flood the house, but that’ll take time.

It’s not an explosion; it’s water torture.

As far as the economy goes, the Jan. 1 deadline is meaningless. There’s no urgency to reach a deal quickly, no reason to abandon long-held principles just for the sake of meeting that deadline.

However, the politics are a very different story. The political pressure to appear reasonable could be so powerful that the two parties could reach a deal that they’ll come to regret. Just as they’ve come to regret their August 2011 deal, the one that created this year’s fiscal showdown.

To review, here’s what would change on Jan. 1:

• The Bush-era tax rates would expire. That would bring higher rates for ordinary income, capital gains, dividends, and estates.

• The annual patch in the alternative minimum tax would also expire, as would several small corporate tax breaks. These are always extended every year, and will almost certainly be extended again next year.

• The payroll tax holiday would end, which would mean a tax hike for every working American.

• Taxes to pay for Obamacare would hit the “rich.”

• On the spending side, about $100 billion in automatic cuts in federal spending would begin to be implemented, half in the defense budget and half in nondefense.

• Extended unemployment benefits would expire, cutting off benefit checks for about 3 million people. That’s going to hurt.

• Payments to doctors under Medicare would be cut, but these reductions have always been canceled in the past, and they will next year as well.

 

The immediate economic impact of these changes would be minor, although it would be negative. The expiration of the Bush tax cuts would be nearly imperceptible. In the event of a failure to reach a deal by the first of the year, it’s probable that the IRS would not change the tax withholding tables right away, so most of us wouldn’t see any impact in our paychecks until the taxes are due on April 15, 2014.

Maybe the countdown clock should say: “517 days” not 45.

The stock market might rally in January. Savvy investors would have sold in 2012 to lock in their capital gains to guarantee the lower tax rate, and once the calendar turned, they’d be ready to swoop in to catch some bargains.

The spending cuts would be implemented immediately, but the impact on the economy would be gradually felt, with the vast majority of federal spending continuing as before. 

 

Contracts that were already obligated would not be affected. Some federal workers (and private-sector workers) would certainly be furloughed, and plans to buy new equipment or maintain old equipment would be postponed. Over time, these cutbacks would begin to hurt the broader economy.

The only components of the fiscal cliff that would have an immediate impact are the parts that are certain to go into effect, no matter what kind of deal is reached: The end of the payroll tax holiday and the expiration of extended jobless benefits.

The increase in the payroll tax (also known as FICA) would be, as President Barack Obama said in 2011, “a big deal.” It would mean $40 less in their paycheck every week.

Just because the impact wouldn’t be instantaneous doesn’t mean it wouldn’t be significant, if it persisted for a full year. The Congressional Budget Office predicts that, if Congress does nothing, the economy would fall back into a recession in the first half of 2013 as the deficit reduction kicks in.

Millions of people would lose their jobs, many businesses would fail and the nation would endure more economic hardship, according to the CBO and many private economic analysts.

That is, if Congress did nothing and left the higher taxes and lower spending in place for a full year. Congress could step in at any time, before or after Jan. 1, to postpone the deficit reduction.
If Congress doesn’t act by the middle of February or so, the austerity will weigh heavier and heavier on the economy with each passing week as the unemployment rate climbs higher and higher.

And that’s when the pressure to cut a deal will be unbearable. When the water from the tub starts flowing into the living room.

 GOODLUCK