As 2012 drew to a close, U.S. media erupted over the impending “fiscal cliff” and its potential to land the United States in a mild recession the following year.
Referring to the sharp decrease in the budget deficit resulting in the expiration of Bush-era tax cuts and planned spending cuts under the Budget Control Act of 2011, the cliff became the political hot topic of late December as proposed fixes split party lines. Additionally, the previously enacted “payroll tax holiday” – a two percent reduction in FICA withholdings intended to stimulate spending – was set to come to an end.
Despite the media’s attention, Professor of Economics Dr. Kevin Christ explained that “the ‘fiscal cliff’ was really more of a fiscal slope.”
“I call it a slope because the changes, if they had come into effect, were not going to have immediate or 'overnight' consequences on the economy (as much of the media coverage suggested), but would instead have introduced drag on the economy gradually during the first half of 2013.”
Christ added that the term “slope” is more appropriate because “there was always going to be a way to retrace steps and climb back up.”
Back-and-forth negotiations began seven months prior when the Senate passed a bill extending tax cuts for all but the wealthiest two percent, but the House rejected the proposal, contending that the cuts should continue in their entirety. With time quickly ticking off the clock, talks continued throughout the holiday season with majority leaders threatening to hold everyone from returning home.
Ultimately, Congress came to an agreement, passing to the president’s desk the American Taxpayer Relief Act of 2012 which Obama signed into law on January 2. Intended to be a short-term resolution for the fiscal cliff, Christ detailed what the bill entails.
“Ultimately, the bill that Congress passed and that the President signed brought back a higher marginal tax rate only on annual incomes above $400,000. There were also five percent increases in tax rates on capital and dividend income, and the payroll tax holiday did go away,” Christ summarized, adding that the spending front was not addressed.
Since details of the bill were released, economic experts have ignited in debate over short-term and long-term implications of the decision. Arguing the full brunt of the “fiscal cliff” was unlikely to take effect, Christ says a recovering economy is not the best time to address long-term fiscal problems, adding that most of the current deficits are cyclical, not structural.
“[T]hey have arisen because we’ve experienced a deep and lingering economic contraction that reduced tax receipts and raised certain forms of government spending," he said. "If the economy were to vigorously recover, those cyclical components of our deficit would begin to melt away.”
While previous economic projections had growth around two or three percent, most forecasts have been greatly reduced, and Christ says that most likely means a drag on the economy.
“This wouldn’t be a major issue if the economy were perking along at 4 percent or 5 percent, but at our recent rates of economic growth, the introduction of these austerity measures now means that it is more likely that the economy will tread water in 2013," he said.
But at least the water level has slowly been going down. Many economists have noted an improvement in the housing market last year – the oft-cited Case-Shiiler Home Price Index rose 4.3 percent in the 12 months leading up to October – and the national unemployment rate has dipped to 7.8 percent.
With the initial fiscal cliff threat in the rearview mirror, Christ says the immediate economic concern is to work toward slow and steady growth.
“The major issue, in my mind, is not to balance our federal budget and solve all of our fiscal issues at once. This means not having our policy makers...unnecessarily introduce new sources of uncertainty and drag into our economic system.”