Avoiding the Plunge: Congress Appears to be Taking Us Toward a Fiscal Cliff

It's hard to believe that Congress will allow the U.S. economy to go over the fiscal cliff that's looming at year's end. Yet given this Congress' oft demonstrated dysfunctionality, it's hard to have any confidence that the dire consequences of inaction will be averted.

Unless the across-the-board federal tax increases and draconian spending cuts that are due to take effect on Jan. 1 get legislatively abated, their chilling impact is considered almost certain to shove the economy back into recession in 2013. The Congressional Budget Office, which is widely respected on both sides of the aisle in Washington, has projected that the nation's gross domestic product will shrink by 2.9 percent in the first half of the year with unemployment rising to 9 percent or higher.

Unlike the last recession that resulted from a housing and financial market collapse of unprecedented and unforeseen proportions, next year's would be self-inflicted by Washington's failure to heed these warning signs. Yet most Republicans seem more fixated on driving down the federal deficit, which is expected to exceed a trillion dollars for the fifth year in a row FY 2013 if none of the presently scheduled tax hikes and spending cuts take effect.

Continuing to pick up deficits at a rate that exceeds 6 percent of the nation's $16 trillion GDP is undeniably unsustainable as is the continuing build-up of the national debt that's due to hit the $16.3 trillion ceiling that Congress set in 2011 by early next year. Just the prospect of having to raise that ceiling once again is likely to traumatize lawmakers as it did in 2011 when the government nearly shut down before Congress finally incorporated an increase into the Budget Control Act that imposed a trillion in ostensible spending cuts over a decade and mandated another $100 billion a year to take effect come Jan. 1.

When push comes to shove, however, averting a recession has to take precedence over fiscal constraint—at least in the short run. Republicans who claim that the fiscal stimulus measures pushed through a Democrat-controlled Congress by the Obama administration in 2009 didn't do any good are dunderheads. Without the $831 billion American Recovery and Reinvestment Act (ARRA), I shudder to think how much deeper that year's Great Recession would have become. And certainly the billions in ARRA funds that flowed to Tennessee prevented a precipitous decline in state funding of public education at a time when state revenues were cratering.

What looms even larger than the impending spending cuts is the estimated $500 billion in increased revenues that would result from the lapse of the so-called Bush-era tax cuts that are due to expire at the end of this year. The Republican majority in the House can be counted on to hold firm for their extension in the lame-duck session of Congress that will immediately follow this November's elections. But the Democrat majority in the Senate seems to be following President Obama's lead in insisting on a restoration of pre-Bush higher tax rates for households with incomes in excess of $250,000. So gridlock could result on both the tax and spending fronts.

About the only encouraging sign in this regard is that both bodies have agreed on an extension until next March 31 of fiscal 2012 spending levels. This will allow time for the newly elected Congress and whoever is elected president to address the totality of fiscal-cliff issues in early 2013. But with the need for a further incendiary increase to the federal debt ceiling thrown into the mix, it's hard to be optimistic that another stalemate won't result.

To break the 2011 stalemate, Congress kicked the can down the road by appointing a purportedly bipartisan Joint Select Committee on Deficit Reduction. As a spur to the committee's coming up with something, the Budget Control Act imposed the now-impending January 2013 automatic cuts in the event it failed to do so, which it did.

Now, as then, Congress and the president still have the ever-so-sensible 2010 recommendations of the presidentially-appointed Bowles-Simpson Commission to look to for guidance in setting the nation on a long-term path toward deficit and debt reduction without doing damage to the economy in the short run. This bipartisan commission stressed that it would take a combination of revenue raising and spending reduction measures to get the deficit back under 3 percent of GDP, which is the maximum that's generally perceived to be sustainable. As opposed to tax rate increases, the commission put its revenue raising emphasis on tax reform coupled with actual rate reductions. One of the biggest reforms is containment of the tax breaks that are presently bestowed on everything from health insurance premiums to itemized deductions for charitable contributions and mortgage interest payments.

As matters stand, these and other tax deductions inequitably favor high-income over middle-income taxpayers. That's because the favored few paying the top 35 percent tax rate get a bigger break than middle-income taxpayers in the 28 percent bracket. Obama has long proposed to rectify this inequality (and raise some revenue) by limiting deductibility to 28 percent for everyone alike, but his proposal has gotten nowhere. Bowles-Simpson has a more elegant solution that involves converting deductions to tax credits as one component of a tax overhaul that gets far too complicated to describe or even summarize in this space.

Comprehensive tax reform is clearly the way to address—and redress—a multitude of inequities in the tax code. Revenue-raising reforms will no doubt take some time to work out, but perhaps that's as it should be in the present fiscal climate. In the meantime, it's imperative that present tax rates remain in effect.

Anyone who doubts that an abrupt swing toward fiscal restraint can cause an economic downturn should look at the recent experience of the United Kingdom. Following tax increases and spending cuts imposed by a newly elected Conservative government, the U.K. economy has shrunk by nearly 1 percent during the first half of this year. Even that pillar of financial rectitude, the International Monetary Authority, has admonished the British to take a more gradual approach to deficit and debt reduction.

That is what's needed in the U.S. as well if a plunge off the fiscal cliff is to be avoided.