WASHINGTON — Congress returned to work this week, and was promptly given one major task to accomplish before the end of the year — stave off the so-called “fiscal cliff.”
That term has been in the political lexicon since Federal Reserve Chairman Ben Bernanke used it to describe the dramatic collision of spending cuts and tax increased scheduled for the end of the year. But the cliff has taken a back seat for more than a month with Congress, the president and the public at large focused on last week’s elections.
So here’s a refresher on what the fiscal cliff is, what it means for the economy, and how it can be avoided.
What is the “fiscal cliff?” Put simply, the fiscal cliff is the name given to the cocktail of spending cuts and tax increases set to take effect at the end of the year. It’s been so fancily named because if the country were to “go off” such a “cliff,” economists agree it would lead to a recession next year.
What taxes are going to go up? What spending is going to be cut? For one, the 2001 and 2003 Bush tax cuts are set to expire, for everyone, on Dec. 31. A 2 percent payroll tax cut is also scheduled to end, as are a series of other tax credits enacted as economic stimulus measures after the 2008 recession. Further, Congress has not adjusted the level at which the high-income Alternative Minimum Tax kicks in, meaning individuals and companies that would not normally pay that higher tax rate would have to do so in 2013.
These make up the brunt of the tax problem, though a lot of smaller tax provisions are also scheduled to lapse or, conversely, take effect next year (like some Affordable Care Act taxes, including one on medical device manufacturers’ revenue that the Minnesota delegation opposes). If the economy goes over the cliff, the Tax Policy Center projects tax revenue to jump by $500 billion, or 20 percent, next year, and it says middle-class families will pay about $2,000 more a year.
On the spending side, the most pressing problems are $600 billion cuts (over 10 years) to both defense spending and discretionary programs. There would be about $110 billion worth of cuts in 2013 alone. Combined, that’s all good for cutting the federal deficit, but potentially very damaging to the economy at large.
How did we get here? It started with the Bush tax cuts, which, when they were put into law, were slated to expire in 2010. During the lame-duck session of Congress that year, President Obama agreed with congressional Republicans to extend the tax cuts for another two years, along with unemployment benefits and the payroll tax cut (for one year), in the name of not hindering the country’s burgeoning economic recovery. Lawmakers extended the payroll tax holiday again last year, and the whole bundle is now set to expire.
The second component, the slate of spending cuts, finds its roots in the 2011 debt ceiling deal. Before Congress agreed to raise the federal debt limit, it instituted a spending cap (saving $1 trillion over the next decade) and formed the (erroneously-named) “super committee” tasked with finding an additional $1.5 trillion in savings over the next 10 years. If the super committee were to fail, the law stated, then spending cuts (divided between discretionary and military spending) would take affect automatically beginning in 2013.
Of course, the super committee failed, and the spending cuts (known in legislative parlance as “sequestration”) are now scheduled to begin.
So, what would happen if we go over the cliff? Assuming lawmakers do nothing (and since no one actually wants to go over the cliff, that’s not too likely), the country would enter a recession.
The non-partisan Congressional Budget Office estimates that going over the cliff, full bore, would mean economic contraction of about .5 percent in 2013. The economy would shed about 3.4 million jobs, bumping the unemployment rate to 9.1 percent.
Preventing different components of the cliff would have various effects on the economy:
- Fixing the Alternative Minimum Tax issue and extending the Bush tax cuts would add or save about 1.8 million new jobs, or about 1.6 million new jobs if only rates on incomes above $250,000 lapse;
- Extending only unemployment benefits and the payroll tax holiday would create about 800,000 jobs;
- And avoiding the cliff altogether (extending the low tax rates and unemployment benefits, preventing the spending cuts, etc.) would allow the economy to save or create 3.4 million jobs — but add $500 billion to the deficit per year.
Experts have noted that calling the situation a “cliff” is a misnomer, that if lawmakers do nothing and send the economy “over the cliff,” the effects would be slower and more gradual than if a person were to go careening off of an actual cliff.
And that’s true, too — CBO’s estimates assume that if Congress does nothing during its lame duck session, it will continue to do nothing through 2013, but that’s not necessarily the case. If the economy “goes over the cliff” at the end of the year, taxes would increase and lower spending would take effect, but the adverse economic effects would take some time to come to fruition. Congress could still come to a resolution after new members are sworn in next year, and if the alternative is economic contraction and massive job losses, it’s likely that lawmakers will do something to avert mass economic tragedy of their own doing.
How will Congress solve the cliff? That’s what we’ll find out over the next six weeks.
At the moment, the debate seems to center on tax rates. Obama has long wanted to allow the Bush tax cuts lapse for individuals making more than $200,000 and couples making more than $250,000, something Republicans have resisted. Obama has already said he would veto any plan that continues those tax cuts, setting up a battle with Republicans who have vowed not to increase rates.
Republicans have opened the door to some new revenue. House Speaker John Boehner said he would be open to closing tax loopholes to help pay for lowered rates and a redrawn tax code, which in turn would lead to economic growth and the increased tax revenue that comes with it. That message is fairly consistent with what Boehner has offered in the past, especially during super committee negotiations, though it could violate a “no new taxes” pledge most of the caucus, including all four Minnesotans, has taken.
Obama has said he’s open to working with Republicans to find a deal — but the tax rate on high-income individuals is going up, like it or not. The White House said on Tuesday that Obama’s starting point for negotiations will be $1.6 trillion in new revenue as part of a $4 trillion 10-year deficit reduction package, though hours later the Republican leader in the Senate reiterated the party’s opposition to higher rates.
Of course, lawmakers can also let the economy go over the cliff (with the effects described above taking place), or it has the option of averting the cliff altogether, repealing the scheduled spending cuts and keeping tax rates where they are and making tough deficit-reduction decisions later — an approach that unearths the Washington metaphor of “kicking the can down the road.”
That would help grow the economy now, but will also lead to higher deficits, which no one in Washington wants, especially with a fresh fight over the amount of debt the country can carry expected to come early next year.
What is the Minnesota delegation saying? Beyond a broad discussion of their basic fiscal cliff opinions, few members of the Minnesota delegation have gone deeply into what needs to be done to address the situation.
For example, in debates with her opponent, Sen. Amy Klobuchar said she favored raising high-income ($250,000-plus) tax rates, cutting spending on tax loopholes like oil subsidies and, more broadly, working with Republicans to find a solution to the problem. Defeated Republican Rep. Chip Cravaack has objected to the scheduled defense cuts (he voted against the bill that instituted them), while liberals like Keith Ellison have opposed cuts to entitlement spending. Ellison said last week that he would be willing to move on spending cuts in those areas only if Republicans allowed higher taxes.
Republican Rep. Erik Paulsen, meanwhile, told MPR on Monday the best course of action would be to stop higher taxes before the end of the year and give the next Congress more time to work on a broader deficit reduction deal.
Paulsen said he, like House leadership, would be open to more revenue, though increased tax rates should be off the table. Specifically, Paulsen said, there could be an income cap above which individuals are not allowed to take deductions. He said every deduction, even popular ones for charitable giving and home interest rates, should be on the table.
“I think bringing in more revenue is an important component that should be on the table,” he said. “I think it’s a mistake to focus just on tax rates. The best conversation to have: How do we actually have tax reform that will bring in more revenue as a part of growing the economy?”
Devin Henry can be reached at firstname.lastname@example.org. Follow him on Twitter: @dhenry