For years the Congressional Budget Office (CBO) has been warning that the federal government’s fiscal course is “unsustainable.” And for just as long, Congress has refused to do anything about it, preferring to defer and delay whenever possible.
The consequences of congressional irresponsibility have been mounting all the while: four years of $1 trillion deficits, a $16 trillion federal debt, and a slew of temporary tax policies. Even routine fiscal decisions have been neglected: For more than three years the Senate has declined to pass a budget, perhaps fearing what an honest assessment of the government’s fiscal situation might show.
It is easy to see why Congress is so keen to ignore these issues. The biggest single driver of the federal debt is Medicare, which faces $38 trillion in unfunded liabilities and is expected to become insolvent by 2024 under even the most accommodating estimates. Social Security, a program that has been running annual operating losses since 2010, faces $20 trillion in unfunded liabilities. Federal spending on Medicaid is scheduled to double by 2022 under Obama-Care, and defense outlays are set to grow by more than
$100 billion during the same period even if proposed “cuts” take effect. The long term gap between spending and revenue is a problem that affects nearly every piece of the federal government, and as CBO Director Douglas Elmendorf said in 2010, it “cannot be solved through minor tinkering.”
This fiscal Jenga tower starts to come crashing down on January 2, when inaction-as-usual will suddenly become a major policy decision. Starting on that day, several of Congress’ kick-the-can games are scheduled to end: A temporary payroll tax cut expires, raising taxes by $95 billion if it is not extended; an estate tax cap disappears, multiplying the number of Americans hit by the tax tenfold; and the income tax rates that were reduced under President George W. Bush return to their 2000 levels. According to an October study by the Tax Policy Center, that last change would affect 90 percent of American households, with average marginal tax rates jumping by five percentage points on labor earnings, seven percentage points on capital gains, and 20 percentage points on dividends.
At the same time, a series of reductions in planned federal spending will also kick in, thanks to the last round of congressional failure to deal with long-term fiscal problems. The 2011 deal to raise the federal debt ceiling included automatic cuts, a.k.a. “sequestration,” in case a bipartisan committee was unable to settle on a deficit reduction agreement. That committee failed to produce a deal, so as of press time budget cuts totaling $1.2 trillion during the next decade were scheduled to become the law of the land after New Year’s Day.
The combination of sequestration and the expiration of tax cuts has been widely described as “the fiscal cliff.” Unless Congress acts at the last minute, between the November 6 elections and New Year’s Eve, the federal budget may go flying over the ledge—and possibly take the nation’s economy with it.
The CBO warned in August that the fiscal cliff is apt to cause a recession. Credit rating agency Standard & Poor’s already has downgraded the U.S. government’s rating, and its competitor Moody’s has said it may follow suit if Congress does nothing to prevent the scheduled tax hikes and spending cuts. Yet avoiding the cliff comes with risks of its own. With deficits at record levels and the federal debt continuing to pile up, failing to address runaway spending would keep the U.S. on an unsustainable fiscal course, with the possibility of a debt crisis looming on the horizon. There are no happy choices.
No matter what Congress does, backing away from the cliff is not going to be easy. “We are at the fiscal endgame,” Reagan administration budget director David Stockman told Bloomberg News in July. “From here, it’s going to be chaos.”
So what should Congress do about the fiscal cliff? reason asked a group of experienced budget policy watchers to explain what the problems are, what we can do about them, and what might happen if we don’t. —Peter Suderman
The Worst of Both Worlds
Without legislative action, millions of Americans’ tax bills will suddenly rise and federal spending will be suddenly cut. Many economists believe that allowing all this to happen simultaneously will have severe adverse economic effects, possibly plunging the nation back into recession.
We are in this situation primarily because elected officials have become addicted to inserting “sunset” provisions into laws they don’t actually intend to terminate. This is a classic game-theory conundrum in which the players all face incentives to do the wrong thing, despite knowing that the end result is bad for everyone.
Political pressure and congressional “pay-go” rules, which require revenue increases or cuts elsewhere in the budget to offset new spending or tax reductions, serve as impediments to laws that transparently add to the deficit. So instead of admitting that many policies we favor do add to the deficit, we pretend that they will only be with us briefly and that their budget effects can be painlessly counteracted with minor offsets.