Breaking Down The Fiscal Cliff In 12 Charts

Investors remain convinced, it would seem, that the fiscal cliff will not happen because our great-and-good politicians in Washington know full-well that the economic repercussions will be too great. Even though Ben’s foot is to the floor, he has stated that monetary policy will be unable to offset the negative economic impact of the tax hikes and spending cuts. The prospect of agreement among a deeply polarized politik and just as Goldman expects, we worry that the S&P 500 will fall sharply following the election once investors finally recognize the serious possibility that the ‘fiscal-cliff-problem’ will not be solved in a smooth manner. In order to clarify that thinking, Bloomberg Brief has provided 12 charts on the timelines, impact, uncertainty, and possibilities surrounding this most obvious of risk events.

The so-called ‘fiscal cliff,’ the confluence of $607 billion in expiring tax and expenditure policies set to take effect at the end of 2012, poses a significant risk to the U.S. economic outlook.

Unless lawmakers reach a compromise to extend some or all of the temporary tax cuts and postpone mandatory spending cuts, the hit to the economy would translate into about 4 percent of gross domestic product.

There will probably be little movement to address the economic consequences of the fiscal cliff until after the November U.S. presidential election. This will leave policy makers the one-month lame duck session of the 112th Congress between Nov. 13 and the currently scheduled day of adjournment on Dec. 14 to reach a decision before the scheduled tax increases and mandatory spending cuts will take effect Jan. 1.

Given political polarization, these issues may well not be addressed until the start of the 113th Congress on Jan. 3, 2013.

Growth And Austerity: This is not the first experience that the federal government has had with periods of austerity. During the Reagan, George Herbert Walker Bush and Clinton administrations, periods of bi-partisan fiscal restraint were seen. Solid growth in the Reagan and Clinton eras contrast with slower growth and an eventual slide into recession during Bush the elder administrations. The major difference between those eras and our current period is historically slow growth occurring at the same time as high political polarization. These conditions are not conducive to a grand bargain to put the nation’s fiscal path on a more sustainable footing and avoid a likely recession in 2013.

The burden of adjustment caused by the significant fiscal restraint that would take place next year would be spread around the public and private sector. The end of emergency unemployment benefits alone accounts for $40 billion in reduced government spending. The Congressional Budget Office estimates that each dollar of unemployment insurance generates $1.55 in additional economic activity.

Defense Spending: automatic sequestration may result in about $55 billion in defense and non-defense accounts from the Pentagon that account for roughly half of the $110 billion resulting from the Budget Control Act of 2011. Based on current statutes, only a new law that terminates automatic defense cuts can prevent sequestration. One result of major cuts in defense spending would likely be the loss of tens of thousands of defense contractor-related jobs. Many of these jobs are held by middle and upper middle class income earners critical to supporting current levels of household spending.

Taxes & Spending

The policies that put the fiscal path on a sustainable footing will likely involve a mixture of spending cuts and tax increases over the next decade or two. In any debate, the most contentious portion of it will revolve around how the burden of adjustment is distributed throughout the economy while supporting growth and reducing unemployment.

Marginal Rates Pre- and Post-Cliff: The sunset of the Bush tax cuts and the expiration of the Obama tax holiday, as well as a variety of tax hikes and spending cuts, will boost marginal tax rates across the board, collapsing the six tax brackets into five. Using a conservative multiplier, the end of the $220 billion Bush tax cuts would result in a reduction in consumer spending of roughly $200 billion or 1.3 percent of GDP. The end of the Obama tax holiday would produce a $95 billion hit to household spending, subtracting 0.6 percent from GDP.

Increased taxes on corporations may not be a good way to encourage growth. While taxes on individuals have come down substantially over the past 30 years, that is not the case when it comes to U.S. statutory corporate tax rates. The 2012 combined government corporate tax rate in the U.S. is 39 percent, trailed by Japan at 38 percent, France at 34.4 percent and Germany at 30.2 percent.

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