The fiscal cliff- not fun, but can be wisely managed

  With all of the attention given to the alleged "fiscal cliff" that would hit in 6 weeks, I figured I'd look at  the actual CBO report on what would happen if all elements of the fiscal cliff hit at once, as well as broke apart the various portions of it.

First, let's see what the CBO says if no deal is made, and isn't made in 2013, so all budget cuts and tax increases hit.

According to CBO’s projections, if all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5 percent in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013)—reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year. That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013. After next year, by the agency’s estimates, economic growth will pick up, and the labor market will strengthen, returning output to its potential level (reflecting a high rate of use of labor and capital) and shrinking the unemployment rate to 5.5 percent by 2018.

So CBO is saying we'd get a small recession at the start of 2013, and back to a slow expansion by the end of the year. Not good, and certainly a sharp difference from the growing economy we've been having, with GDP rising at 2% in the third quarter of 2012, and possibly to be revised higher with upward employment revisions and housing starts at its highest levels since 2008.

But not doing anything would also cut $502 million in deficit in 2013 compared to what we have now, and $682 million in 2014. Now some of that would be offset by the lower growth that would result, but if you think the number 1 priority is to reduce the deficit (which dropped by $200 billion in the last fiscal year, but was still at $1.09 trillion for FY2012), then you should be demanding to go over the fiscal cliff.

Of course, the flip side is to extend every one of these provisions, which would continue to keep our deficit at huge levels, but the CBO also adds that our GDP growth would be 2.4% for 2013- pretty similar to the 2.2% we've had for the last 12 months. Since we now know the 2 extremes (doing nothing or expanding everything), let's break it down into a few parts.

First, let's talk taxes. Let's look at the Bush tax cuts, as well as President Obama's plan to raise taxes on the rich back to 1990s levels, while keeping the Bush tax cuts for everyone else. The CBO has the tables that go under all of these scenarios, and we'll also look at what happens if the 2%% cut in Social Security taxes stays in, or goes away.

Effects of tax policies from CBO
Keep all Bush and Soc. Security tax cuts- GDP +2.1%
Taxes for rich goes up, all other taxes stay same- GDP +2.0%
Social Security taxes go up, taxes for rich go up- GDP +1.3%

Remember, this is a change compared to what would happen if the entire cliff hit, not the total GDP growth number. So the biggest takeaway from that is that keeping the Bush tax cuts for the rich would do virtually nothing to add to GDP over keeping the tax cuts for the lower levels of income and allowing the rich to pay more. The Social Security tax cuts are projected to give a lower increase in GDP growth vs. keeping the Bush tax cuts and reforming the AMT.

Now, let's look at the deficit effects of these policies

Effects on 2013-2014 deficit of tax policies from CBO
Keep all Bush and Soc. Security tax cuts- Deficit up $1,008 billion
Taxes for rich goes up, all other taxes stay same- Deficit up $928 billion
Social Security taxes go up, taxes for rich go up- Deficit up $670 billion

As someone who thinks Social Security should be protected, and as someone who knows that the Bush tax cuts for the rich have taken wages out of the pockets of workers and into the hands of the wealthy and corporate, allowing those two tax measures to happen would be acceptable to me. Sure, it's slower growth (by about 0.8% GDP), but we'd survive on low GDP growth (much like we did in 2011), we'd still be able to create some jobs (and possibly with more wages), and our deficit would be reduced. It also makes Social Security more secure, which also will lead to long-term stability and economic growth. That works for me.

As for the spending side, the CBO says that getting rid of the spending cuts for the military would increase GDP by 0.4%, and getting rid of the discretionary spending cuts would increase GDP by another 0.4%. They also have a much smaller effect on the deficit than the tax measures.

Effects on 2013-2014 deficit of tax policies from CBO
Restore spending cuts on military- Deficit up $75 billion
Restore domestic spending cuts- Deficit up $101 billion

Even though the effect on the deficit is smaller, I'd favor the military spending cuts, because domestic cuts are much more likely to trickle down to the state level, and cause increases in taxes and additional spending cuts that would further hamper the economy well beyond the federal cut effects.

So if I were to strke a grand bargain, I'd accept

1. Bush tax cuts to remain for lower-income people.
2. Bush tax cuts on rich and Social Security tax cuts go away
3. Military spending cuts allowed to continue
4. Domestic spending cuts rescinded

The final result, (according to the CBO)

GDP growth up 1.7% from the "fiscal cliff nightmare" scenario, but down 1.2% from the "everything stays" scenario. If everything else stays the same, that means 1.2% GDP growth for 2013.

It also means the deficit is $771 million higher than under the "fiscal cliff nightmare" scenario, but it's also down $413 billion from the "everything stays" scenario. Sure, the deficit stays relatively high, but it should continue to fall and is manageable.

And it sure would beat the recession that Europe has fallen back into due to their irresponsible austerity. The chronic cycle of "deficit cutting = recession = more deficit cutting = more recession" is what I fear would happen if we followed a Paul Ryan-style policy, and that's the worst result we could have. So let's not go there, OK?