How the Fiscal Cliff Deal Hurt a Recovering Economy
The deal that Congress came to on the fiscal cliff last week was a combination
of half-measures, compromise, and kicking-the-can that nobody seemed to like
but was overwhelmingly approved. Most of the meaures that constituted the
cliff stood poised to harm the economy over the next two years - and Congress'
failure to offset the cost of averting the cliff will result in a worse
economy in the long run.
As Americans everywhere found out with their first paychecks of the new year,
Congress failed to reauthorize the temporary payroll tax cut that expired.
This could result in between 300,000 and 1.3 million fewer jobs created over
the next two years. Reauthorizing the payroll tax cut, however, would have
needed budget-tightening offsets to minimize long-term damage to the economy.
While the effects of the high-income tax hikes will be somewhat mitigated due
to Congress raising the income threshold, it's still going to cost the economy
some jobs in the short-term.
Economist Peter Morici estimates that unemployment will remain steady next year when what obviously needs to happen is that the economy grows and unemployment shrinks. And in the long-term, Morici writes, "the likelihood of a downgrade in the U.S. credit rating by Moody's is increasing, and this will weigh on the investment plans of many U.S. multinational corporations.
While averting most of the fiscal cliff will help in the short term, it'll
cost us in the long term. For example, the full extension of unemployment
insurance is estimated to add 0.5% to economic growth next year, but because
everything in the cliff - including the tax cuts - is deficit-financed, the
U.S. will be worse off in ten years than if nothing was done.
The Congressional Budget Office's analysis of the cliff legislation last week
Although we expect that the legislation just enacted by the Congress will lead
to higher output and income in 2013 we also expect that it will lead to lower
output and income later in the decade than would have occurred under prior
law. The legislation lowers tax rates for many people—thereby boosting output
—but it also expands budget deficits—which will reduce national saving and
lower the stock of productive capital, thereby reducing output relative to
what would have occurred under prior law.
The fiscal cliff deal was a massive compromise between many different and
competing factions and, therefore, has no coherent vision for the economy. As
Jim Tankersley of the Washington Post explains:
Economists generally offer three theories for what’s hampering the still-
sluggish U.S. economy: the Keynesian theory, which would like to see lower
taxes or more government spending; the spending/debt theory, which would like
to see both of those reined in; and the uncertainty theory. Under none of them
can the deal to avert the “fiscal cliff” be considered an economic success.
Like almost all legislation that comes out of "grand bargain" sessions in
Washington, the fiscal cliff was far from the optimal outcome. Yes, it's not
the worst thing that could have happened, but there's a very good case to be
made that the legislation that resulted, because it likely won't be offset
down the road, has made the U.S. worse off in the long run.