Commentary

How US Politicians Will Respond to the Looming Fiscal Cliff

By Tad DeHaven
This article appeared in City A.M on December 3, 2012.

One of the few things that politicians in the United States are good at is dealing with a problem by kicking the can down the road. That’s what happened in August 2011 when Republicans and Democrats reached an agreement to avoid breaching a statutory ceiling on the federal government’s mounting debt.

The agreement included the creation of a “Super Committee”, tasked with achieving $1.2 trillion (£748bn) in deficit reduction over ten years. When, unsurprisingly, the committee failed, the agreement stipulated that the deficit reduction instead be achieved through a combination of automatic cuts to defense and non-defense spending (“sequestration”).

Republicans, obsessed with military spending, and Democrats, obsessed with domestic spending, desperately want to avoid the sequestration cuts, which are scheduled to go into effect on 1 January 2013. In addition, the Bush and other tax cuts are scheduled to expire on the same day. This combination of tax increases and spending cuts is what the American media is referring to as the “fiscal cliff.” Keynesian prognosticators (the same people who said massive deficit spending would get the U.S. economy humming again) calculate that going off the “cliff” would spark another economic downturn.

The Congressional Budget Office, for example, says that the combination of spending cuts and tax increases would push the economy back into recession and increase the unemployment rate to 9 per cent. Such warnings have given Republicans ammunition to resist proposals for tax increases and cuts to military spending. And it has given Democrats ammunition for their opposition to other spending cuts while allowing them to support the continuation of tax cuts for all but the “wealthy.”

Republicans are correct that increasing taxes won’t help the economy. And Democrats are being disingenuous when they suggest that a debt crisis can be averted by confiscating more money from “the rich.” Regardless, President Obama’s re-election means that taxes on wealthier Americans are going to increase.

Republicans still control the House of Representatives, so Democrats will have to offer up reforms to the entitlement programmes bankrupting the country (like Medicare) in order to get legislation to the President’s desk. Unfortunately, the reforms that Republicans get are unlikely to amount to much more than tinkering. And the reforms will probably be structured so that they won’t actually go into effect for years.

The cumulative result will be a tax increase now in exchange for a promise to slow the growth in federal spending in the future. The American military-industrial complex will be spared the full brunt of the sequestration cuts, so domestic spending programmes may expect a similar reprieve. Democrats will claim an outright victory and Republicans will claim a moral victory. If this is indeed how the situation plays out, American politicians will have once again kicked the can. And the true victor will be the status quo.

Tad DeHaven is a budget analyst on federal and state budget issues for the Cato Institute.