“Under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases.”
– Ben Bernanke, first usage of “fiscal cliff”, 29 Feb 2012 (Hat tip Kevin Drum)
It’s hard to say if Bernanke actually planned to attach the specific label “fiscal cliff” to the series of spending and tax changes that are scheduled to begin at the start of next year. The above comment came during a Q&A after his formal testimony in the Semiannual Monetary Policy Report to the Congress; the testimony itself did not include it.
But the appeal of the term was obvious. It signaled an immediate and irreversible and perilous economic harm pending just on the other side of the New Year — and also made possible a lot of asinine metaphorical extensions (of the US economy “tumbling off the fiscal cliff” or policymakers “driving us over the fiscal cliff” or whatever).
If you’re in charge of US monetary policy and trying to accelerate a recovery amid a devastating long-term unemployment problem, you want fiscal policy to either complement your efforts or at least be neutral, not work against you. “Fiscal cliff” is a lot easier than “policies contributing to tighter fiscal policy beginning next year”.
And so the term might have been useful to help focus the collective media and policymaker attention on what would have to be done after the election — and to give everyone a facile way to lump all of these looming tax cut expirations and sequestration cuts into a short and highly suggestive phrase.
Too facile. It worked, but the problem with “fiscal cliff” is that the metaphor kinda sucks, as so many commentators have now taken to explaining. If policymakers don’t work out a solution by January 1st, the harm is not immediate. Nor is it irreversible, nor is it even all that perilous at first. And even to describe the various components as a single item is problematic: each would have a different effect on the economy. (See the charts posted by Gavyn Davies, or Kevin Drum, or Calculated Risk for a breakdown.)
Last Friday the Congressional Budget Office released its latest forecasts for how damaging to next year’s economy each policy would be if left alone. But the forecasts assume either that the various policies going into effect on January 1 would remain in place throughout all of 2013, or that they would not be offset by some other negotiated measure. But this is unlikely; something that can be negotiated on December 28 can also be negotiated on January 4 or January 14 with only trivial economic damage in the meantime.
From this morning’s FT:
Going off the cliff for a couple of weeks might mean a loss of as little as 0.1 per cent of output, prompting flogging the thesaurus in a search for cliff synonyms that are closer to a nursery slope than the black run at Verbier.
One issue that often gets associated with the problems of the “fiscal cliff” is that the longer negotiations go on, the more the uncertainty about its resolution hurts the confidence of businesses and households. As we’ve noted before, this concept always makes us a little suspicious. Not that it doesn’t matter, but it’s extremely difficult to measure in real time just how much it does.
And to the extent that it does matter, logically the issue should be whether households and businesses are confident that a deal will be reached within a short while after January 1 — before the economic damage goes from trivial to non-trivial — not that it would be reached by January 1. This is before getting into the question of whether even if businesses do hold back on investing while the negotiations play out, they won’t simply make up for it with more spending after. There’s a real possibility that later we’ll be proved wrong about this; we’re just pointing out that the existing evidence for the uncertainty case seems weak.
Anyways, all of these various items didn’t suddenly materialise when Bernanke mentioned them. They were obvious well before then. His “fiscal cliff” made them easier to talk about, but it also made the talking-about misleading.
Other fiscal cliff/slope/staircase/whatever stuff
Last week we flagged an item by Scott Galupo of the American Conservative, who made the case that Mitt Romney’s idea to cap the total amount of deductions available to US tax filers could be a potential solution, and we explained why the idea had a particular elegance to it. (Though we’ll quickly add once more that we think the best solution would be a simple postponement of the whole thing for six months or a year, but that seems unlikely.)
To rehash quickly, Romney’s problem was that he floated the idea as a way to pay for his reduction in tax rates, but those cuts were too big to be offset by this idea to cap deductions alone. But that doesn’t mean that the deduction cap is a bad idea. It would 1) raise additional revenue by targeting higher-income earners while leaving alone the middle class if designed properly (Democratic win) while 2) leaving tax rates themselves in place (Republican win), and 3) it simplifies the tax code without having to target specific deductions to eliminate, leaving that decision to tax filers themselves (an everybody win).
Greg Ip also had a great post about it on Friday, making a few similar points while calling it the “Obamaney tax plan”, but also adding some numerical estimates:
I don’t have a ready estimate of how much capping deductions for those earning more than $250,000 would raise. But you can ballpark it by looking the Tax Policy Center’s estimates for capping itemized deductions at $50,000. It would raise $749 billion over 10 years, within the $800 billion that Mr Boehner has previously agreed to. That’s also more than the $429 billion yielded from returning the two top rates to their pre 2001 levels.
The appeal for Republicans is that no one’s rates go up, and the preferential rate for capital gains and dividends is preserved. The appeal for Mr Obama is that it is highly progressive. According to the TPC, less than 1% of the bottom 60% of households would pay more tax while the top 1% would pay 79% of the additional revenue. The average tax rate for the bottom 60% wouldn’t change, while it would go up 2 percentage points for the top 1%.
It’s worth noting that Mr Obama’s budgets proposed capping the value of deductions for upper income households at 28%, which would have raised $584 billion over 10 years.
Prior to 2001, the personal exemption and itemized deductions phased out for upper income taxpayers; those phaseouts were eliminated by the Bush tax cuts. Mr Obama’s budget would reinstate them, raising $164 billion over a decade. (These provisions would raise considerably less revenue if the two top rates did not go up.)
(We’ve broken up the pars to make it easier to read.)
There were some hopeful noises made by politicians over the weekend about the possibility of a solution. But right now it seems like they’re talking more about targeting individual deductions and loopholes rather than a cap on total deductions. We’ll see.
UPDATE: Matt O’Brien of The Atlantic also has an excellent post about this.
The sticking point
We don’t have a larger point to make here, but we thought this chart from the Center on Budget and Policy Priorities (using CBO data) was interesting. It shows the macroeconomic impact of one of the biggest points of friction in the discussions between the Democrats and Republicans — whether to extend the Bush tax cuts on incomes above $200k for single tax filers and $250k for married couples:
We’re not here to take a side in the debate over taxes on high-income people, only showing that the macro impact of this particular part of it is really quite minimal.