It’s a Slope Not a Cliff

June 4th, 2012 at 6:51 pm

That’s how my CBPP colleague Chad Stone describes the fiscal contraction set for the end of this year when tax cuts expire and automatic spending cuts kick in.

It’s an important and salutary distinction.  Go over a cliff, and you’re pretty much toast, like at the end of Thelma and Louise.  Start down a slope and if you turn around soon enough, you don’t have to go down too far.

What’s the distinction?  Why the semantics?  Because if policy makers fail to distinguish between cliff and slope effects, they might be drawn into extensions of the expiring policies that do more long-term economic harm than we’d get from a short trip down the slope.   And the most notable such expiration is the high-end Bush tax cuts.  That should sunset on schedule at the end of this year.

For the health of the economy in 2013-14, the important issue with respect to the tax cuts is to ensure that tax cuts for low- and moderate-income households do not expire; the fate of the Bush tax cuts for the top 2 to 3 percent of taxpayers should be of little economic consequence in 2013 and 2014.  Moreover, if only the tax cuts for lower- and middle-income households are extended, high-income taxpayers will still benefit from the reduced tax rates on the full portion of their income that falls in the lower tax brackets.  CBO’s analysis indicates that a cost-effective way to continue using the tax cuts to shore up the weak economy would be to extend the middle-class tax cuts for a year or two, allow the upper-income tax cuts to expire, and extend the tax-credit expansions targeted on low- and moderate-income households.  Such an approach would provide the most “bang-for-the-buck” in terms of supporting the economic recovery in 2013-14 without seriously compromising long-term fiscal sustainability.

None of this is meant to be cavalier.  As I’ve written elsewhere and stressed to anyone who will listen, the last thing this economy needs right now is another self-inflicted wound.  It would be better to resolve this tomorrow, but that’s extremely unlikely.  That means that if Democrats and the White House hold out for high-end sunset, we most likely start down the slope in January of next year.

I worry—a lot—about that outcome.  The expirations of the payroll holiday and the middle-class tax cuts mean that paychecks will fall noticeably right away (through greater withholding in the latter case).  And the automatic cuts are already creating uncertainty about the near future among government contractors.  And one can be forgiven for imagining that the politics of compromise are not in a hugely better place in 2013 than they are today.  A few weeks, maybe a month down the slope will hurt, but it’s unlikely to be seriously damaging to growth.  A few months…that’s different.

But that doesn’t mean we should just give up on better policy outcomes.  Too often in these situations, someone yells “fire” (i.e., recession!) and policy makers scramble to kludge together something, most often under the heading of kicking-can-down-road.

And, in fact, a partial can-kick makes sense here.  Most of this stuff should be extended until the economy enters the virtuous cycle I describe here.  But a full-can-kick doesn’t.  And given the fact of our revenue needs and the small multiplier on the high-end tax cuts, their time has come.

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4 comments in reply to "It’s a Slope Not a Cliff"

  1. perplexed says:

    -”Moreover, if only the tax cuts for lower- and middle-income households are extended, high-income taxpayers will still benefit from the reduced tax rates on the full portion of their income that falls in the lower tax brackets.”

    Its time we had some stringent standards for what can qualify to be called “stimulus” spending. When such a huge portion of what we’re forgoing in revenue simply goes to pay down debt or add to the coffers of our oligarchs, the deficit goes up without any of the effects that “real stimulus” would have. This just feeds Republican propaganda saying that stimulus spending doesn’t work. If a huge proportion of the money isn’t getting to those with a high MPC (which it isn’t), we’re probably better off letting all of the tax cuts expire on schedule and minimizing the risk of these being made permanent. Unless Obama wins AND Democrats win big in both the Senate & House, new revenues will be incredibly hard to come by. With unemployment benefits expiring for so many, we’re probably better off collecting additional revenues to offset the increases in food stamps and medicaid. As long as Republican obstructionist are able to block all real solutions, we should be thinking in terms of bracing ourselves for the inevitable consequences and not risking the permanent extension of these tax cuts.


  2. Stuart says:

    I’m discouraged by this line in your post:

    “the important issue with respect to the tax cuts is to ensure that tax cuts for low- and moderate-income households do not expire”

    and later:

    “a cost-effective way to continue using the tax cuts to shore up the weak economy would be to extend the middle-class tax cuts for a year or two, allow the upper-income tax cuts to expire, and extend the tax-credit expansions targeted on low- and moderate-income households. ”

    I know you mean that it’s important for the economy, that a sudden tax rise for low and moderate incomes would be a drag economically, and I agree, obviously. I agree that continuing current (Bush) low taxes for them while raising taxes on higher incomes is the simplest way to do that. It is also an impossible way of doing it, I think. If we hold to that first quote we might as well admit that all of the Bush tax cuts are permanent, because the Republicans will demand continuation of the high-end tax cuts as a price for continuing those cuts for middle and lower incomes. This was true last year, and it will be true next year and every future year for all of time.

    Trying to parse the Bush tax cuts into high and middle and low is a losing proposition, a losing negotiating position, that I think should be abandoned. There is no remaining honorable purpose in bashing our heads bloody against that wall over and over again, or bashing our country’s head against that wall. Obama—if he is still President when the fiscal “slope” begins its ugly decline—has two realistic options: continue ALL of the Bush tax cuts, or let ALL of them expire and propose a different tax cut, an Obama tax cut, that is weighted toward relief for low and middle incomes.

    If he chooses that path he has a chance of winning the fight. If he keeps trying to negotiate a finely parsed outcome with a grim and unyielding opposition he will always lose.


  3. davesnyd says:

    In an interview with Time a couple weeks ago, Romney agreed that the disaster scenario couldn’t be permitted.

    That, it seemed to me, was a tacit admission that Keynesian economics is correct and I’m surprised nobody has called him on it.

    But he also said he wanted to wait until after he was sworn in to do anything about it so that it could be done right.

    That, it strikes me, is tantamount to holding the Nation hostage for his own political goals. It’s wrong and it should be called out as such.


  4. Michael says:

    I hope you’re getting paid for this stuff. Because it’s pissing in the wind. We’ve got a Presidential contest between a right-wing and a wingnut-right-wing candidate, and Congressional candidates climbing all over one another to promote austerity.

    So, great, put up the statement, so we can say “I told you so” later. But there’s no hope of sanity in the next four years.


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