The fiscal cliff is the convergence of three laws: the expiration of the two-year extension of the Bush tax cuts of 2001-03 ($280 billion); the expiration of Obama payroll tax cuts and emergency unemployment benefits ($165 billion); and the onset of spending cuts mandated by the Budget Control Act of 2011 ($103 billion). Together, they represent a 3.5 percent negative hit to GDP were current law to remain in effect on Dec. 31. We have not experienced a comparable event since the end of the Korean War.
The third element, the Budget Control Act of 2011, was signed by President Obama in August of 2011 when Congress last approved an increase in the national debt. The act established the Joint Select Committee (also known as the Super Committee) to produce deficit reduction legislation that would be immune to amendment or filibuster. The committee failed in its efforts to do so and the act provided for the process of sequestration: across the board spending cuts in defense and discretionary spending.
In the language of game theory, our intelligent rational decision-makers have been absent since the third quarter of 2011. Their mathematical models have enumerable equations of conflict and no equations of cooperation.
There are consequences for our failure to deal with the fiscal cliff. The Congressional Budget Office baseline forecast is for a negative GDP of 1 to 1.5 percent in the first half of 2013 if no modifications are made. Analytically, our representatives should be seeking to create a balance where we sustain economic growth in the short run but provide a clear path to budget deficit reduction and debt containment in the long run. The economy is too weak to accept a one-shot $560 billion reduction in the budget deficit. We should phase-in the tax increases and spending reductions over some designated time horizon to strike the necessary balance.
A little budget math is in order. In 2011, federal government receipts were $2.3 trillion; expenditures were $3.6 trillion; and the deficit was $1.3 trillion. Defense spending was $712 billion and discretionary non-defense spending was $566 billion. It is readily apparent that we could eliminate all discretionary expenditures and still not balance the budget from current revenue. In relation to GDP, expenditures were 22.9 percent of revenue (1.9 percent above the 21 percent normal) and revenue was 15.7 percent of GDP (2.7 percent below the 18.4 percent normal).
Given the math, it is obvious that both taxes must rise and spending must fall. So why haven’t lawmakers dealt with the issue in the interim? Surely, there are some areas of agreement where trade-offs can be made to demonstrate some progress. Cynics will say that the business of getting re-elected comes first. Elections have consequences and this one is important. But the expiration of current law and the onset of legislation are predictable and the people’s predictable business should be dealt with in a timely manner.
A conservative Congress led by Newt Gingrich and President Bill Clinton was successful in creating fiscal balance in the 1990s but only after the government was shut down. The most recent increase in the debt ceiling was quickly followed by rating agency downgrades of our debt because of the perceived willingness of the Congress to accept default as part of the negotiating strategy. Both are examples of the conflict equation in game theory.
But are we really willing to create legislative patchwork in the midst of the crisis that will surely result from falling off the fiscal cliff? The global economy is weak. The economic uncertainty that would result from allowing the cliff to be triggered in order to improve negotiating position, in this environment, is not an acceptable position. The calendar leaves a limited window to resolve this issue. It is time for intelligent rational people to write the equations of cooperation and do the peoples’ work.