Fiscal Cliff 2013: The Bigger US Problem Is Unemployment, Not The Deficit

The reason? The so-called fiscal cliff isn’t really a "cliff." Think of the U.S. budget situation as more akin to the temperature in your living room on a typical fall day as we approach December and winter. (If you live in the Northern Hemisphere.) If you turn down the thermostat in your living room to 70 F degrees or 68 F degrees, it may feel a little less warm in the room, particularly if it’s a cold night outside. If you turn the thermostat down slightly again the next night, to 66 F degrees, you may feel slightly chillier, but you’re still not anywhere near a temperature that’s unhealthy nor life-endangering.

No Budget Deal Like A Cool Room: Hardly Hazardous

The budget situation in the United States today is like the aforementioned temperature in that living room: We’ve turned down the thermostat slightly, but we’re not in any mortal danger. Not arriving at a budget deal by Jan. 1, 2013, is not going to "freeze" the U.S. economy and lead to a recession. Rather, it may cool it a little more, and at some point make it feel a little more uncomfortable.

And the reasons are obvious enough. First, if a budget agreement is not reached, there won’t be an immediate income tax hit to the economy if action is not taken on taxes: The IRS on Jan. 2 probably will not adjust its tax tables that determine taxes withheld for employees because they sense Congress and the president could reach a budget deal shortly thereafter that would require the IRS to – you guessed it – tear up the revised tax tables and lower them again.

Hence, there will not be some sudden “drag” on the economy from paychecks on Jan. 1. All of the contractionary damage that a lack of a budget deal has triggered has already affected the economy: it’s already slowed the economy, in the form of the changed psychology and consumer hesitancy that’s permeated 2012 and will continue until something positive happens to improve the psychology. Not getting a budget deal by Jan. 1 will not slow the economy further.

Second, the most likely budget deal - which could occur in December or January, possibly February – one in which the income taxes are raised on families with income over $250,000 per year and individuals over $200,000 – would hit the income groups that are least likely to affect the economy. The income tax increase for these groups would be about $52 billion to $60 billion per year, depending on the methodology one uses to project federal revenues. Moreover, this money is not the same, in GDP-significance terms, as middle-income and working-class income tax increases. Raise income taxes on the rich and upper-income groups, and they might have a little less surplus money in the bank or in stocks and bonds, or (for some) in a hedge fund. But raise income taxes on middle-income and working-class adults, and bang! Right there – you’ll immediately see a reduction in consumer spending, particularly on new cars or SUVs, appliances and furniture, and a host of other products and services these adults buy. These groups have decidedly less disposable income. Hence, unlike an income tax increase on the rich, an income tax increase for typical citizens will cut into their disposable income – and in many cases affect their decision to buy big-ticket goods. Some may even delay purchasing a home. All of which would move the GDP growth needle lower.

Therefore, we’ve seen how the lack of a budget has already been baked into the lower U.S. GDP growth estimates, and how the most likely income tax increase – on rich and upper-income adults – won’t lower GDP. Hence, nothing dramatic is going to happen on Jan. 1, 2013, if a budget deal isn’t reached. Or on Feb. 1, 2013, for that matter.

Sans The Sequestration Hysteria

The same can be said regarding “sequestration” – the roughly $100 billion in automatic spending cuts - half from the U.S. Department of Defense, half from non-defense programs. Can anyone show me a schedule in which DOD starts closing military bases or other federal agencies starting to lay off federal employees on Jan. 2 if President Barack Obama and congressional Republicans don’t reach a budget deal on Jan. 1? I doubt if one exists, and no, the nation won’t experience mass federal layoffs, or an increased "threat to national security" with "reduced battle-readiness" on Jan. 2.

Perhaps the latter three will begin to occur on March 2 or May 2, but not on Jan. 2, which only underscores my point.

GDP Needle-Movers: Payroll Tax, Extended Unemployment Benefits

That said, there are two issues in the budget talks that will affect jobs, U.S. GDP, and most importantly the economic and social conditions of millions of Americans, if Obama and Congress don’t act: the extension of the payroll tax cut and extended unemployment benefits.

The payroll tax that funds Social Security was cut to 4.2 percent from 6.2 percent in December 2010, and that break ends in February 2013. If an extension is not passed, that would mean a tax increase for every working adult – and that would affect consumption and U.S. GDP.

Also, extended unemployment benefits are set to expire on Jan. 1, 2013. If the president and Congress don’t act to extend these benefits, 1 million adults will lose their benefits at the start of the new year, and another 1 million will lose them in the first quarter of 2013. A failure to extend this critical benefit – which extends a lifeline to families and individuals and almost always is spent very quickly on housing, food, and utilities – would substantially decrease consumption and hurt the economy.

The Living Room Is Getting A Little Cooler

Yours truly chose the thermostat-living room analogy for a reason: With the budget deal talks and ominous warnings about a “fiscal cliff,” the United States is about to act in ways that would cool the economy gradually, not heat it up.

Furthermore, right now policymakers should be trying to heat the living room up, not cool it down. The bigger problem in the United States now is not the budget deficit, but unemployment. The nation is still short about 12-13 million full-time jobs. Hence, policymakers should be focused on programs and fiscal policies that create jobs, and that reduce the budget deficit, long-term. They should not have as their goal solely cutting the budget deficit in a big way quickly.

In sum, if no budget deal is reached Jan. 1, there won’t an income tax table change, those income taxes that are likely to be increased in a deal achieved by February or March won’t hurt GDP, and sequestration will not occur.

The re-inauguration of the president in January 2013 marks an important fiscal time for the United States, to be sure, but a fiscal cliff, it ain’t. Therefore, Washington should remain focused on programs and policies that create the millions of full-time jobs the American people seek.