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Deal or No Deal

picture of model retirement nest egg on financial newspaperOver the past few months, the approaching “fiscal cliff” has been prominent in the news, both before the presidential election and now after. Avoiding this potentially damaging event is certainly one of the top priorities of both the legislative and executive branches of government. But what exactly is the best description for this scenario?

What is It?

By now, nearly everyone has heard the term “fiscal cliff” for the major economic events scheduled for the end of 2012: comprehensive spending cuts passed by Congress in 2011 to lessen the deficit, expiring federal tax cuts as well as new tax cuts starting in 2013. Different organizations have put forward a number of projections, such as the Congressional Budget Office’s (CBO) estimate that the U.S. economy would contract by an annualized 2.9 percent in the first half of 2013 and by 0.5 percent over the entire year if nothing is done. And that’s the key to the “cliff” description, that no substantive action is taken by Congress, an unlikely proposition.

Many ideas put forward by politicians and economists have called for contributing revenue while reducing individual income tax rates. While there are few who would object to either as an alternative to raising tax rates or cutting entitlements, there’s a “reality check” moment when looking closer at these ideas. Programs like the mortgage interest deduction, charitable contribution deductions and the exclusion of employer-provided health insurance from income deductions are enormously popular. It’s one thing to suggest trimming tax expenditures, quite another for a politician to specify which ones to cut.

Regardless of where negotiations go in the coming months, this particular confluence of higher taxes and lower government spending is certainly striking and worthy of a good catchphrase. But as Congress and President Obama outline their positions, it’s a good time to take a closer look at the terms used to describe this scenario.

It’s a Slippery Slope, This Cliff

Is it a “cliff,” really, or more like a “slope” in that the effects might be spread out over a longer period of time than the first week of January 2013? “The economy will not go over a cliff and immediately plunge into another Great Recession in the first week of January.” That’s what Chad Stone, chief economist at the Center on Budget and Policy Priorities, recently asserted in a paper that argues a failure to extend the tax cuts before January 2013 will not plunge the economy into an immediate recession as is often portrayed in many headlines. Stone does not suggest the effects of this fiscal slope would not have serious economic consequences; however, his main point is that the effects would be relatively modest at first, then growing in potential severity if not adequately addressed for the long-run by Congress.

“The greater danger is that misguided fears about the economy going over a ‘fiscal cliff into another Great Recession will lead policymakers to believe they have to take some action, no matter how ill-conceived and damaging to long-term deficit reduction, before the end of the year rather than craft a balanced plan that supports the economic recovery in the short term and promotes fiscal stabilization in the intermediate and longer run.”

The Congressional Budget Office came to similar conclusions earlier in 2012:

If policymakers wanted to minimize the short-run costs of narrowing the deficit very quickly while also minimizing the longer-run costs of allowing large deficits to persist, they could enact a combination of policies: changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period.

Austerity Bomb

Another term that’s gotten some circulation (Brian Beutler, Paul Krugman, for instance) for this particular alignment of forces is the phrase “austerity bomb,” the idea that slashing spending and raising taxes on ordinary workers in a depressed economy shares striking parallels with the current economic crisis in Europe. In fact, some observers of the recent troubles in Greece and Spain suggest that cutting spending in a depressed economy can be destructive and actually slow the progress of economic recovery rather that stimulate it. What those using the bomb analogy point out is that to avoid austerity along the European model (the bomb), there are compromises to be struck that can lead to positive economic growth. And that may mean extending the Bush tax cuts while not enacting all the automatic spending cuts or some similar arrangement.

A Way Forward

Terms and definitions do matter, as does the perception of a situation. Like the limitations of the term “cliff,” implying that a detonation is going to be triggered January 1, 2013 also seems to miss the bigger point. The larger and long-term questions that will need to be decided by both our politicians and the American people are the proper size of our federal government and the proper distribution of the tax burden. These are real issues that our politicians must face in the coming months as they deal with an issue that is larger than just what happens on January 1, 2013.

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