‘Fiscal Cliff’ May Be Felt Gradually, Analysts Say
Come January, if Congress fails to act, spending cuts and tax increases large enough to throw the country back into recession will hit.
It is known in Washington as the “fiscal cliff.” But policy and economic analysts projecting its complicated and wide-ranging potential impact said the term “fiscal hill” or “fiscal slope” might be more apt: the effect would be powerful but gradual, and in some cases, reversible.
“The slope would likely be relatively modest at first,” Chad Stone, the chief economist at the Center on Budget and Policy Priorities, a research group based in Washington, wrote in a recent analysis. “A relatively brief implementation of the tax and spending changes required by current law should cause little short-term damage to the economy as a whole.”
The annual effect of the automatic tax increases and spending cuts would be enormous. The Congressional Budget Office has estimated that the budget deficit would shrink by more than half a trillion dollars from fiscal years 2012 to 2013 and that the economy would very likely enter another recession.
Nearly all Americans would see their tax bills increase, with income and payroll taxes climbing, credits shrinking and levies on investment earnings soaring. The Tax Policy Center, a Washington research group, has estimated that the average family would see its tax bill go up $3,500 and its after-tax income drop 6.2 percent.
At the same time, mandatory federal spending cuts would compel agencies across the government to reduce their budgets by billions. A study by the economist Stephen S. Fuller of George Mason University and sponsored by the Aerospace Industries Association, a trade group based in Virginia, has estimated the related job losses at as many as 2.14 million.
The potential economic damage has led a spate of economic heavy hitters — from the International Monetary Fund, Wall Street, foreign capitals, the Federal Reserve, and elsewhere — to urge Congress to act before year’s end.
Noting the fragility of the recovery, Ben S. Bernanke, the chairman of the Federal Reserve, described avoiding the cliff as the “most effective way Congress could help to support the economy right now.”
But both Democrats and Republicans have said that going over the fiscal cliff might put them in a better negotiating position. And confidence in policy makers’ ability to get a deal done is low.
In the event that New Year’s Day came and went without a legislative fix, confidence, investment, markets and household spending would be hurt, analysts said. Still, there would be time for Congress to strike a deal before the economy started contracting. The economic effect would accumulate day by day, and much of it might be reversible.
The Treasury Department has significant discretion over whether to adjust the withholding tax tables, meaning it could choose to keep last year’s rates and avert much of the blow from the tax increases. Policy makers could also apply lower tax rates retroactively: If the Bush-era tax cuts expired for all households in January, they could be reapplied in February.
“It would be quite easy,” said Eric Toder of the Tax Policy Center. “Technically easy. I don’t know about politically easy.”
Congress does need to address the alternative minimum tax; a patch to ensure that millions of families do not pay higher taxes this year is broadly expected but not in place.
“A lot of people would be very surprised to see how big their tax bill will be,” said Nigel Gault, the chief United States economist for IHS Global Insight. “That’s a pretty urgent one to take care of, so that tax forms can be properly prepared for 2012.”
Even if the tax increases hit in January, families might not notice the incremental loss of income in the near term, economists said. Households might temporarily dig into savings to maintain their spending on the gas, food, housing and other consumer goods, mitigating the impact the tax increases might have on the broader economy.
“The consumer has relied on savings to bridge the loss of disposable income from tax increases” in the past, said Jacob Oubina of RBC Capital Markets in New York.
Moreover, while the fiscal cliff would be enormous in annual terms, its effect would be cumulative, not immediate, analysts have noted. Households hit by the tax increases might not notice the $10 or $100 missing from their paychecks, even if it would damp their spending over the course of the year. Agencies hit by the spending cuts might not act immediately.
Perceptions of Congress’s progress on forestalling some of the tax increases and spending cuts might also prove important in January, analysts said.
If the White House and Congressional leaders seem incapable of reaching a deal, that might cause significant market panic, intensifying the economic blow from the tax increases and the spending cuts.
Mr. Gault said that in such a case the economy would be under a cloud of “extreme uncertainty,” alarming investors, depressing consumer confidence and hurting businesses.