How Can We Solve the Fiscal Cliff Situation?

This entry is part 8 of 9 in the series The Fiscal Cliff Explained

Part 8 – How Can We Solve the Fiscal Cliff Situation?

There are 5 components in this section of The Fiscal Cliff Explained:


Just Go Over

The simplest option for Congress and the White House would be to do nothing. Taxes would go up. The military and domestic spending cuts in the sequester would bite down. This would be the single largest act of debt reduction in American history, cutting some $1.2 trillion from the deficit over the next two years. Trouble is, that much austerity would likely also induce a recession. That’s why few policymakers advocate this scenario.

There’s another problem with this plan: Lawmakers can’t just sit back and do absolutely nothing. Even if the tax hikes and spending cuts kick in, Congress would still need to vote to lift the $16.4 trillion debt ceiling by February or so. Otherwise, the United States government would no longer be able borrow money to fund its obligations. That could be trouble.


Just Go Over and Then Make a Deal

Another possibility is that lawmakers don’t reach a deal by Dec. 31. The United States goes over the fiscal cliff. But it’s only temporary. After all, those tax hikes and spending cuts don’t kick in with full force immediately. They’re spread out over two years. So there’s still time to make a deal when the new Congress convenes in January.

Why would lawmakers do this? It might make a deal easier. Right now, the two parties are having a tough time reaching an agreement because Democrats want higher taxes on the wealthy and Republicans mostly refuse to vote for any tax increases at all. But if we go over the cliff, taxes automatically go much, much higher than either party wants. Now the two parties simply need to debate how to cut taxes from this new baseline. That’s a happier discussion, in theory.

The downside is that Congress and the White House might not have much time to negotiate a deal in January or February before financial markets start nosediving.


Extend

There’s nothing stopping Congress and the White House from postponing the fiscal cliff until 2013 or 2014. Congress would simply vote to extend all (or some) of the Bush tax cuts and payroll tax cuts. Then Congress votes to override the sequester, so that none of the military and domestic spending cuts kick in. Suddenly, the fiscal cliff is gone–or at least pushed back.

The upside here is that there’s no recession. The economy gets time to mend. The flip side is that deficit would continue to grow–the CBO estimates U.S. debt would be $1.2 trillion higher over the next two years if Congress extends everything, compared with if we went over the cliff. Plus, we’d face another big showdown two years from now.


Small Deal

Congress doesn’t need to make a big sweeping deal on the debt right now. It could do something smaller. One possibility being talked about is that Republicans would let the Bush tax cuts for income over $250,000 expire, as Obama wants. That would raise about $80 billion in 2013. In return, Democrats would find $80 billion in spending cuts. Then Congress extends (most) of the rest of the tax cuts.

That’s a small bit of austerity next year, but nothing like the full cliff. And lawmakers could continue working on bigger tax reform in 2013.


Grand Bargain

At the moment, there’s a lot of talk in Washington about a “grand bargain” between Republicans and Democrats. This would involve avoiding sharp austerity in 2013. It would also involve some mix of spending cuts and tax increases that are gradually phased in over the next decade, so as to slowly bring down the U.S. national debt. It would also include substantial changes to entitlement programs like Social Security, Medicare and Medicaid. Examples of a “grand bargain” framework include the Simpson-Bowles plan, or the Domenici-Rivlin plan.


Series Navigation<< What Do the Parties Agree and Disagree on Concerning the Fiscal Cliff?Wonkbook: Everything you need to know about the fiscal cliff deal >>
Tagged , , , . Bookmark the permalink.

Leave a Reply