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Lawmakers Should Think Twice Before Going Off the Fiscal Cliff Lawmakers Should Think Twice Before Going Off the Fiscal Cliff

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Magazine / ANALYSIS: BUDGET

Lawmakers Should Think Twice Before Going Off the Fiscal Cliff

Some argue that if Congress tumbles over the edge, it can climb back up to fix things later. But by then, it may be too late for the economy.

A long way down: Best not to fall.(AP Photo/Dan Nephin)

November 1, 2012

Call it bravado, or even recklessness. Some Democratic lawmakers stare at the fiscal cliff and wager that jumping off it might not be so bad. Sen. Patty Murray, D-Wash., has urged her party to play tough on the cliff—a combination of year-end tax hikes and automatic spending cuts—to force Republicans to accept higher tax rates on the wealthy. She said last summer that a plunge would be preferable to a deal “that throws middle-class families under the bus.” A few GOP deficit hawks say they, too, would take the leap if that were the only way to tame the deficit.

Suddenly, somehow, this represents an increasingly influential line of thought among analysts and writers. The argument is that Congress could at least partially cancel out the hikes and cuts retroactively in 2013, so there’s no need for a deficit-reduction deal during the lame-duck session. The cliff is a “bad metaphor,” and missing the deadline by a “week, a month, or even a couple of months” would not cause an economic calamity, Jonathan Chait wrote in New York magazine. Mark Zandi, chief economist at Moody’s Analytics, agrees: “You’re going to take a step off the cliff, but that doesn’t mean you’re going to hit bottom,” he says, adding that the economy would be no worse off a year from now.

That’s an awfully risky proposition. Today, the fragile economy is still not firing on all cylinders. In the third quarter this year, it posted a modest 2 percent growth rate. Legislators may like the idea of putting off negotiations until 2013, thinking they’ll have more leverage after the inauguration if their presidential candidate wins. But this political gamble has economic costs: Even a short jump off the cliff, say economists, could send the country back into a recession.

 

If all of the Bush-era tax cuts expire and the full array of “sequestration” cuts take effect, they would lash a roughly $600 billion drag to the economy during 2013 if those policies were left in place all year, according to the Congressional Budget Office. True, nobody expects the cuts to remain in place all year, and the shaken financial markets might finally jolt Congress into striking a deal. But the psychological damage if lawmakers head home for the holidays without averting the cliff could have lasting effects.

The lack of a year-end deal would unsettle consumers, businesses, and financial markets, says Ellen Zentner, senior U.S. economist at Nomura Securities International. The negativity could feed on itself, leading Americans to stop spending and businesses to stop hiring and investing. Even a temporary expiration of the cuts could lead to a quarter of negative growth in gross domestic product, Zentner says. Her firm already expects GDP growth to slow to a crawl in the first quarter, advancing by a mere 0.5 percent. Because consumer spending accounts for more than two-thirds of GDP, another drop in such spending could push the economy into a contraction.

Nervousness about the cliff has hampered growth in the business sector for several months. Business investment shrank 1.3 percent in the third quarter, the biggest drop since late 2009. The pullback in investment dovetails with a recent Business Roundtable survey that found pessimism of CEOs hitting a three-year high. Analysts found that fears about the fiscal cliff were driving much of the pessimism. Yet even though businesses have turned cautious, a complete Washington stalemate could still blindside Wall Street. “We don’t think the markets have it priced in whatsoever,” Zentner says. And if businesses are pessimistic now, imagine how they’ll feel if Congress plunges from the cliff.

Economists’ rule of thumb defines a recession as two back-to-back quarters of falling GDP. Another recession would drive up unemployment, potentially stifle a nascent recovery in the housing market, erode purchasing power, and leave Americans feeling even more disillusioned by Washington’s leadership.

Meanwhile, a deal is looking less and less likely. The presidential election probably will be decided by a razor-thin margin, hardly enough for either candidate to claim a mandate for budgetary policy. Neither party looks able to achieve a filibuster-proof majority in the Senate. And despite President Obama’s promise that partisan passions will cool after Nov. 6, there’s no reason to believe that Congress will be any less polarized. “To get the two sides together is going to require some very difficult and protracted negotiations on tax reform and entitlement reform. These things aren’t going to happen in a couple of weeks or even a couple of months,” says Michael Hanson, senior U.S. economist at Bank of America/Merrill Lynch in New York City.

“It reminds me of the Wile E. Coyote and the Roadrunner cartoons where you run off the cliff and you’re suspended in midair for a little bit and you think everything is OK,” Hanson says. Lawmakers who zip off the cliff may even think they’ve done so with impunity—for a little while. “And then gravity takes over and you hit the canyon floor pretty hard.”

This article appeared in print as “All In.”

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