Some Argue Fiscal Cliff May Not Be All That Scary

Originally published at Capital Gains and Games. [1]

Remember the “fiscal cliff” that everyone from Federal Reserve Board Chairman Ben Bernanke to analysts of every political stripe to media pundits have been talking about so incessantly in recent weeks as something that absolutely has to be avoided?

Yes, that fiscal cliff: the one we’ve repeatedly been told will result in end-of-the-world damage for the economy as the clock strikes midnight on Jan. 1 and the one that has been driving up the nation’s collective blood pressure to such an extent that we’re all going to need the economic equivalent of Valium to get through the coming months.

Well, it turns out that the cliff isn’t that scary after all, really shouldn’t be seen as the moment when all economic hell will break loose and isn’t actually something that has to be avoided at all costs.

At least that’s the conclusion of a well-conceived, well-written and convincing analysis released last week by the Center on Budget and Policy Priorities that explains why fears induced by the fiscal cliff are “misguided” and won’t “plunge the economy into an immediate recession.”

A quick word about the CBPP: Almost everyone takes its analyses seriously. Its staff includes not only some of the most reputable federal budget analysts in Washington, but the analysts that other analysts go to for information, advice and reality checks. They’re highly experienced, credentialed and credible. Even those who disagree with the CBPP’s politics seldom, if ever, argue with its understanding of the budget process.

That’s only one of two reasons I found the CBPP’s analysis that the cliff isn’t as scary as we’ve been told to be so convincing. The other is that the analysis ignored the frightening headlines and instead considered the actual mechanics of how the federal budget works. In doing so, it discovered (actually, “reminded” is probably more accurate) that little happens instantly in the world of the federal budget.

The CBPP’s conclusion is simple: There will be little immediate effect if the increase in taxes and cuts in spending that will happen during the period from midnight Dec. 31 to midnight Jan. 2 go into effect.

In other words, there is no steep fiscal cliff off of which the U.S. economy will take an abrupt nosedive if the tax increase and spending cut policies are triggered.

The CBPP correctly points out that the spending cuts scheduled to occur Jan. 2 because the anything-but-super committee failed to agree on a deficit reduction plan are reductions in spending authority. The actual reductions in spending — “outlays” in federal budget jargon — won’t occur all at once as the visual image of a fiscal cliff virtually demands you picture, but rather, as the CBPP says “over the course of the year and into subsequent years.” Therefore, there will be little immediate direct negative effect and an inability or unwillingness to make a decision by Jan. 2 will not plunge the economy into darkness.

The same is true of most of the fiscal cliff tax changes. The CBPP points out — again quite correctly — that the individual income tax increases will not immediately reduce taxpayers’ cash flow by the total but rather by a very small amount. And the increase in the alternative minimum tax for those who become subject to it for the first time in 2012 because it isn’t fixed by Dec. 31 won’t be felt at all until each taxpayer files her, his, or their tax return for the year. Given that a taxpayer doesn’t typically receive the W-2s they need to file until later in January, that means that there will be plenty of time to deal with this retroactively before it starts to bite.

These spending cuts and tax provisions alone make up more than half of the projected direct effect of the fiscal cliff. Add the limited immediate effect of the other provisions, and the fiscal cliff becomes one of the biggest misnomers and misconceptions in federal budget history.

That’s a good thing because, as I’ve explained in a previous column, last-minute, desperate legislating in a lame-duck session of Congress in general is never a good idea. It’s especially not something that should be planned or hoped for when the decisions, like these, are potentially momentous and the time pressures appear to be extreme. In the current hyper-partisan take-no-prisoners political environment in Washington that could be even worse between Election Day and the start of the next session of Congress, that’s a recipe for a policy disaster.

That’s why the CBPP analysis is very good news. The wisdom that has become increasingly common since Bernanke first uttered the phrase “fiscal cliff” is not as accurate as we’ve been told up to now.

Yes, as the Congressional Budget Office pointed out in its bold report from several weeks ago, the combination of spending cuts and tax increases that will occur Jan. 1 and 2 will, if they’re not modified, push the U.S. economy into a recession.

But that won’t happen instantly and, no matter what’s being said, Congress and the White House don’t have to agree to just any deal to resolve the situation by the time these policies are triggered to prevent the projected damage.