dumb question about the fiscal cliff

[Yo_Mama]

7. Taking a stab at it

What's referred to as the "fiscal cliff" is what is about to happen under current law. This is the total effect of a number of laws, which include the following:

1) The expiration of the payroll tax cut, which will raise taxes 2% for every worker. (This is going to go into effect, it seems from the current negotiations).

2) The expiration of the Bush tax cuts, which would also raise taxes on all Americans. The details of the tax brackets can be found here:
http://taxfoundation.org/sites/taxfoundation.org/files/docs/fed_individual_rate_history_nominal%26adjusted-20110909.pdf

On the lowest income Americans, the tax rate would increase by 5%. Thus, combined with the expiration of the payroll tax cut, some lower income individuals would wind up paying 7% higher in federal taxes. The actual effect would be more, because standard deductions were increased, tax credits for children were increased, and the credit for child care was increased. So some unlucky lower income households could see net increases of federal taxes of something like 20%.

It is true that the tax rate for high income households would increase by about 4.6%, but in fact the combination of the two changes would mean that lower income households paid more of a relative increase than higher income households. This is why President Obama has never been in favor of letting the Bush tax cuts expire for most households. There was a huge low income tax cut in the various changes in the 2001 & 2003 tax bills, and I don't know anyone who thinks that lower income households can afford such a large tax increase right now, given the trends in their real incomes.

Also AMT (alternate minimum tax) would increase taxes very significantly for a range of middle income households.

3) Sequestration: The budget negotiations (debt limit increase) of last year included provisions to cut spending automatically if Congress didn't do it on their own specifically. This change automatically cuts the federal budget very significantly. For details, see this:
http://www.cbpp.org/cms/?fa=view&id=3635
In 2013 the automatic cuts are estimated to be about 109 billion, split equally between defense and non defense. There is a statutory 2% cut in Medicare reimbursements to health care providers. Otherwise the cuts are equally divided across various non-mandatory spending programs.

4) Cuts to extended unemployment benefits.

The "fiscal cliff" as it now stands amounts to about 550-600 billion spread across the year. The major components are about 110 billion in increased payroll taxes, about 109 billion in decreased federal spending, and somewhere around 400 billion in other tax increases, which are very unevenly distributed across the tax-paying population.

That would add up to something like 50 billion less a month in nominal GDP. Absolutely no one believes that the US economy can withstand that without entering an acute recession, thus the worry of the fiscal cliff. To understand why, see the latest GDP release:
https://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp3q12_2nd.pdf

Over the last four quarters, nominal (current dollar) GDP has risen about 470 billion dollars. This is less than the amount of the money that would be taken out of the economy by the fiscal cliff, so it is pretty obvious that the US economy would contract if we let the fiscal cliff take effect.

Now there are an increasing number of analysts who believe that the US has already entered recession, which is why the Fed is putting an extra 40 billion a month into the economy (or trying to) via extra bond purchases. But that stimulus doesn't circulate well, so even doubling it is unlikely to avoid severe recession if we go into 2013 without making changes.

CBO estimated that GDP in 2013 would be reduced by 4% under current law:
http://www.cbo.gov/sites/default/files/cbofiles/attachments/FiscalRestraint_0.pdf

That is on the order of a 2% contraction in GDP. The CBO analysis is old (it dates back to May), and the US economy has notably weakened since, so their projections of the net effect are too optimistic. Negative economy feedback effects would be stronger, and increased spending on unemployment benefits and food stamps and so forth would cost more.

This link shows how unequal the impact would be for some of the groups who would be affected if we let current law continue:
http://online.wsj.com/article/SB10001424127887323717004578159671321634656.html?mod=googlenews_wsj#project%3DFISCALCLIFF1112%26articleTabs%3Dinteractive

It starts out with the shocker of a 55% tax increase for an unemployed person with very low income, but that is correct. The college student example is also definitely in the ball park. Most of the $1,400 tax increase for a low-income married couple with children comes from the much lower child tax credit, but obviously a couple with an income of 30K can't afford to pay even $700 in extra taxes.

Effects on that scale on individual households have a much bigger economic effect than one would expect by spreading it across the population; consumer expenditures would be sharply cut for a range of households, and loan defaults would rise, which would further tighten credit standards and have negative economic feedback effects.

There's at least a 50% chance that we are currently in a recession. Even if all the the above were reversed (current law extended), there is at least a 75% chance that we would fall into recession in 2013, although probably a mild one.

Thus there is at least a chance that we will not see an agreement on the fiscal cliff because everyone wants to blame the current situation on someone else.