Saturday, June 23, 2012

A Trigger for the "Fiscal Cliff"

Under current law, taxes will rise significantly and government spending will be cut next year.  This scenario has been called the "fiscal cliff" and the CBO recently estimated it would lead to a recession in early 2013.

In the Hartford Courant, I suggest going over it, but gradually, when the circumstances are more favorable:
The tax increases could be made to occur at a more appropriate time by instituting triggering criteria that would delay them until the state of the economy has improved and then phase them in. For example, the tax changes could be set to begin once the unemployment rate has fallen to a more reasonable level, like 5.5 percent, and remained there for six months. At that point, the increases could occur in three or four steps, with each one occurring as long as the unemployment rate has remained below a specified level for six months.

This would minimize the risk of pushing the economy back into recession by waiting until the economy has recovered enough to bring the unemployment rate down to a level more consistent with a healthy economy. It would also create confidence that the U.S. is not headed for a debt crisis (though low interest rates suggest that financial markets are not worried about this now). An automatic trigger would take the guesswork out of deciding on an appropriate time frame for an extension of the tax cuts, and spare the country further political brinksmanship over renewing them again.
This is another form of "state contingent" fiscal policy that I've suggested previously on this blog.

In the piece, I asserted that allowing the 2001/03 income tax cuts and the 2010 temporary payroll tax cuts to expire would generate revenue "roughly consistent with the amount of spending required to maintain current programs." This is based on the idea that this would be pretty close to the "extended baseline scenario" in the CBO's projections where the US debt-to-GDP ratio gradually declines over time.  As Jared Bernstein notes, the implication is that the US can afford its current entitlement programs, if it allows scheduled tax increases to take place.

In addition to the tax increases - essentially a reversion to the tax code at the end of the Clinton administration (we did pretty ok back then, didn't we?) - the "fiscal cliff" scenario also involves some spending cuts under the "sequester" mandated by last summer's debt ceiling deal.  Since I was trying to keep the piece to op-ed length, I focused on the tax part because it is larger, but similar logic could be applied to the spending aspects.

The argument is not that this is an ideal economic policy - I'd like to see more stimulus now, and a simpler, more progressive tax code in the long-run; others would like cuts to entitlement programs and lower taxes - but rather that, as a modest change to existing law, it might be a politically feasible alternative to unrealistic hopes of a fiscal "grand bargain" that can achieve a "not bad" outcome in the short- and long-run.

1 comment:

greg said...

Since the wealthy do not spend all their income, and the government does, a tax increase on the wealthy would be stimulatory. As in fact would any tax increase on the wealthy that does not reduce their expenditures to the same degree. Picketty and Saez's 65% or so tax rate on the wealthy would be great for the economy.

Can the wealthy afford it? See:

One of the depressive factors in the economy is the increasing sequestering of money by the wealthy, depriving the real economy of its circulation. This is another way of saying the recent increase in economic inequality is bad.

Since most of the government's expenditures stimulate demand, cutting govt. spending will be bad: Bankruptcies and foreclosures galore. But everybody knows this. Why some (wealthy and powerful) people want it is another thing. An asset grab, perhaps?