What the "Fiscal Cliff" Means

In a tweet, it's bye-bye to those 'evil' Bush tax cuts and hello to across-the-board federal spending cuts and new taxes. Below is a list via AP, followed by an argument that the cliff could save us from a worse crisis.

Say goodbye to:

• Bush's decade-old package of(1) cuts to lower marginal tax rates for everyone [rates below], (2) the elimination of the marriage penalty on working couples, (3)larger personal tax deductions for dependent children, (4) lower tax rates on dividends and capital gains, and (5) a variety of smaller tax cuts for businesses, research and development, and some state sales tax deductions;
• Obama's temporary 2% cut in the paycheck FICA tax; and
• Unemployment benefits for the long-term jobless.

Say hello to:

• the imposition of the Alternative Minimum Tax on some 26 million households, which will raise their taxes by an average of $3,700;
• a sharp cut in Medicare reimbursements to doctors taking care of grannies (the "doc fix");
• the Sequestration: an automatic across-the-board cut next year of $55 billion in federal domestic programs, including another 2% cut to grannies' Medicare doctors; and $55 billion, 9% cut in defense spending.

(New taxes are also slated to begin in January 2013 to pay for Obamacare, but those are not part of the "fiscal cliff.")

Some see the fiscal cliff as the lesser of two evils. The economists @ idealtaxes.com blog argue:

The entire discussion of the "fiscal cliff" has things a bit backward. People talk of "going off" the fiscal cliff — and the natural image is of the disaster that awaits one who tumbles from the edge of a precipice. Instead, perhaps we should say "running into" the fiscal cliff — the cliff being a force that stops a tumble.

Running into a cliff isn't fun. It would raise nearly everyone's taxes. It would cut spending on most of the programs everyone uses. It would temporarily raise unemployment rates. But the fiscal cliff would back us away from a true disaster scenario, and it would slow the growth of the government debt.

While media focus on one warning from the Congressional Budget Office (CBO) report (i.e., that unemployment could go up if we hit the cliff), the authors argue a greater disaster awaits if the cliff doesn't slow the federal debt:

The media has been relatively quiet about the second paragraph of the CBO report -- that without fiscal responsibility, the U.S. economy faces imminent disaster. The CBO wrote:

If the fiscal tightening was removed and the policies that are currently in effect were kept in place indefinitely, a continued surge in federal debt during the rest of this decade and beyond would raise the risk of a fiscal crisis (in which the government would lose the ability to borrow money at affordable interest rates) and would eventually reduce the nation's output and income below what would occur if the fiscal tightening was allowed to take place as currently set by law.

The actual scenario is even worse than the CBO makes out.  If the U.S. national debt continues to explode, then, eventually, when the Federal Reserve raises interest rates to prevent inflation, the rising interest rates will greatly increase the interest component of the federal budget.

From then on, either alternative would be a disaster: (1) the federal government could default, or (2) the Federal Reserve could take the brakes off inflation. In either case, the dollar would collapse in the currency exchange markets, interest rates and import prices would go sky-high, and the U.S. standard of living would hit the bottom with a splat.

UPDATE: John Hinderaker breaks down the marginal tax rate changes.

• Bush rate 35% goes up to Obama rate 39.6%
• Bush rate 33%  ... to ... Obama rate 36%
• Bush rate 28% ... to ... Obama rate 31%
• Bush rate 25% ... to ... Obama rate 28%
• Bush rate 10% ... to ... Obama rate 15%