The Fiscal Cliff: Where Politics and Economics Meet

Maybe we haven’t seen anything yet.

Sure, Washington has been filled with partisan bickering for the past few years, but as the republic prepares to sail over a fiscal cliff it seems likely that the debate and rhetoric in our nation’s capital will be characterized by a heightened sense of urgency and increased vitriol.

“There’s always a chance that we will have, instead of a ridiculous series of fights and idiotic debates, a good outcome,” Washington Post and Bloomberg columnist Ezra Klein told participants at the 2012 SVIA Fall Forum. “It’s a small chance—it’s connected to that Mayan asteroid thing—but it’s a chance.”

In a wide-ranging analysis of the economic problems confronting Washington and the political considerations that play into its decisions, Klein said many who see a realistic chance of a good outcome like to point to the Simpson-Bowles deficit-reduction plan as a possible route to reform. But, he contended, very few people seem to know what’s in it. If they did, he said, they might not be so optimistic about its chances of gaining widespread support in Congress.

The plan, he said, includes $2 trillion in tax increases, more than President Obama has proposed. It also includes about twice the level of defense cuts Obama has proposed. It includes Social Security cuts that neither party has proposed, healthcare savings that rely on a stringent cap in healthcare spending, and a tax-reform plan that gives Congress responsibility for nailing down specifics. Still, Klein said, it will be important for Washington to act at some point. The impending fiscal cliff refers to a combination of automatic spending cuts and tax hikes scheduled to take effect beginning on January 1, 2013. The good news? It would pretty much resolve the nation’s budget deficit problems. The bad news? It would, by most economists’ projections, quickly send the country into a devastating recession. It also wouldn’t be a smart way to do policy, Klein warned, since its spending cuts would be imposed indiscriminately across many programs. “It’s an incredibly blunt instrument,” he said.

What the fiscal cliff might not be, though, is an actual cliff, but rather more of a slope, since much of the savings come in over a period of 10 years. Depending upon who the next president is, Klein said in his early October address to the SVIA, Congress could take quite a while before coming up with a solution—perhaps waiting until sometime in 2013, or even 2014.

Still, he said, both political parties have strong incentives to avoid the cliff. The cliff policies would allow the Bush tax cuts to expire, for example, when almost everyone agrees that comprehensive tax reform would be a better idea. And, Klein argued, the tax increases it imposes are on a scale that no Democrat would be prepared to propose, while Republicans have an even stronger aversion to tax increases. The latter point alone, he said, should drive Republicans to the bargaining table. Yet nothing looks to come easy on this front. The fiscal cliff issue is further complicated, Klein noted, by the fact that the federal government is on track to bump up against its debt ceiling early in 2013. The last time that happened it became a partisan issue, with Congress failing to pass a debt-ceiling increase until the last possible moment.

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