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What is the Fiscal Cliff?

I thought i 'splained this to you people, but i must have not been clear enough because i was looking at the comments on a Yahoo News article (i know, i know: Father forgive me for i am a glutton for punishment) and i kept seeing comments like "These politicians keep talking about the Fiscal Cliff but they want to RAISE TAXES instead of GETTING RID OF THE DEFICIT!!!!11".

Forget the fact that raising taxes reduces the deficit. The whole point of the fiscal cliff is that it will reduce the deficit.

What is the fiscal cliff?
The fiscal cliff is a poorly labeled catch-all for a few laws that will be expiring. I'm going to focus on three:

  1. The expiration of the Bush Tax Cuts

  2. Automatic spending cuts in military and domestic spending (This is often called "sequestration" in the press)

  3. The expiration of a Payroll Tax Cut

(A fourth item is an expiration of "temporary" corporate taxes that have always been temporary and Congress always extends anyway.)

Why is there a fiscal cliff?
There are three different and unrelated reasons, each associated with the three laws i mentioned above.

  1. The Bush Tax Cuts were passed through reconciliation and were deliberately made temporary so that they would not have an impact on the long term deficit. Why weren't they permanent? Part of it was so that they would look less damaging to the deficit than they were. Part of it is due to the archaic rules around reconciliation. The tax cuts is supposed to have expired already but they were extended once during the Obama administration.
  2. The spending cuts were part of a deal that was made the last time we raised the debt ceiling. Raising the debt ceiling used to be a routine and non-partisan thing. But the Republicans took a stand on it last time. And in return they got a non-binding agreement that the government would reduce the deficit by some dollar amount in the future, and if they failed to, there would be automatic cuts in spending. The government failed to reduce the deficit (because of Congressional gridlock), so now the automatic spending cuts are going to happen.
  3. The Payroll Tax Cut was a temporary stimulus measure passed in 2009. Why weren't they permanent? Because a stimulus is by design supposed to be temporary. And this was as far as Congress was willing to let them run (some people hoped the depression would be over by now, some were just worried about getting it past election season, and Republicans were hostile to the idea of a "conditional" extension that went away automatically when unemployment reached a certain number).

Is the fiscal cliff a bad thing?
The fiscal cliff reduces the deficit by raising taxes and cutting spending. So if you are a deficit hawk, you should like the fiscal cliff and hope that no one does anything about it. However, just about every politician and pundit that positions themselves as a deficit hawk has been screaming about the fiscal cliff using very contorted reasoning. Why? Because they don't really care about the deficit, they just want to reduce domestic spending. So the tax increases and the military cuts are problematic for them.

Economic liberals don't like the fiscal cliff because of the short-term effects. Right now, with low interest rates and high unemployment, we don't want to reduce spending. Just as spending increases have a large stimulus effect and tax cuts have a small stimulus effect, spending cuts have a large anti-stimulus effect and tax increases have a small anti-stimulus effect. In the long run, when we are out of our depression, liberals would like to see an increase in taxes, at least on the rich, but don't think this is the right time to do it.

The Obama administration has basically given up on stimulus and is hoping that the economy will recover on its own and is strong enough to survive some anti-stimulus. So they don't count as economic liberals in this scenario (if they ever did).

The politics and priorities
Bush tax Cuts
Obama would like to permanently extend the Bush rates for middle-income families (because they are popular and because it will keep the anti-stimulus effect small) and remove them for upper-income families (it's important to remember that we have a graduated income tax; i'll explain more about that later). If the Bush tax cuts expire, they will expire at all income brackets, which is a larger increase than Obama wants. It's also obviously a larger increase than Republicans want (which is zero). So Obama is better off letting the Bush tax cuts expire and then passing a new law that extends cuts for middle-incomes only. Obama will be in a better negotiating position if he lets the tax cuts expire rather than makes a deal during the lame duck session, because the Republicans will feel more pressure from their constituents to get back some of what they lost. This gives the Administration more leverage to create a bill that is favorable to Dem priorities; it is really the only leverage Obama will have to pass anything in Congress until 2014 (at least).

Spending Cuts
Regarding sequestration, if we must have spending cuts, liberals came away with the better side of the deal here. The deal forces cuts in the military, but gives the Obama Administration discretion regarding which domestic programs have to be cut. Medicare and Social Security were excluded from the deal. Of course, liberals prefer NO domestic cuts and most elected Democratic politicians also do not like to cut the military. So the Democrats may use the renegotiation of the Bush Obama tax cuts to reduce the cuts here; the more revenue we bring in from increased taxes, the less they will have to cut to make their numbers.

Payroll tax cuts
Of all tax cuts, the payroll tax cut had the strongest stimulative effect. This is because it affects more people; even working people who don't make enough to qualify for income tax still have to pay payroll tax. So from that perspective, liberals would like to see a temporary extension again. But liberals are also wary of this tax cut, because the payroll tax is what funds Social Security. The Obama administration has assured everyone that these cuts won't affect Social Security, but it's difficult to see how that is true, especially the longer they are extended. I assume the gap is now made up out of the regular budget, and the more Social Security becomes a line item in the regular budget instead of a self-funded service, the more vulnerable it is. But i expect that the Obama administration will seek another temporary extension of the payroll tax as part of the tax cut renegotiation deal as well.

What to watch for
The main thing is to see how far along things get before a deal is made. As i mentioned above, the best thing for the Obama administration to do is to wait until January to make any deals. Anything Obama agrees to during the lame duck session is less than he would get during the next session.

Then it's a question of what's in the deal. Again, if the deficit is your top priority, you really hope that no deal is made. If you're more concerned about short term economic problems, you hope the current status quo is restored and even a new round of spending is introduced (you might as well also wish for unicorns). The compromise position is somewhere in between, and it's just a question of which tax brackets get the increases and which spending programs get the cuts.

Did i explain anything?
This is much wordier and less bullet-pointy than i envisioned.

By fnord12 | November 15, 2012, 1:53 PM | Liberal Outrage


Yes, like the reasonable Nancy Pelosi and Maxine Waters, I would as soon negotiate with a rattle snake. http://shar.es/6Vt46

I'm not sure what relevance you think Maxine Waters has to the conversation since the agreement has to be made between House Republicans, Senate Democrats, and President Obama.

But feel free to contact your representative and tell him or her not to negotiate. As i wrote above, a failure to come to an agreement means automatic tax increases and automatic defense spending cuts. And while that's not an ideal policy outcome for me, i suspect i'll like it better than you will.

Reference from SuperMegaMonkey

And as i've described here before, that Fiscal Cliff was the last time that Obama was going to have any leverage with the House Republicans.    Read More: Yes, the Platinum Coin means that our political system is hopeless