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An Upside to Automatic Federal Budget Cuts

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GROGAN
Pundits, politicians, economists, barbers and taxi drivers all speak of the so-called fiscal cliff as if it were a bad thing. Is it really? Is it really even a cliff?

Lets back up a bit and take another look at what is going on. What are the consequences of going over the fiscal cliff? First, that supposed devastating tax hike. Not going to happen!

Both political parties are firmly locked into maintaining lower tax rates: the Republicans for 100% of taxpayers and the Democrats for 98% of taxpayers. At first glance, that's not an insurmountable gap. But even if it is, so what?

The Republicans have lost the battle for saving tax breaks for the top 2% of income earners, unless President Obama proves to be a totally inept negotiator.

Review the debates this past election and you'll realize Obama cannot possibly renege on his emphatic promise to raise taxes on the rich before he is even inaugurated for his second term. Democrats hold all the cards. All they need to do to win is do nothing. How hard can that be?

Having done nothing, the Democrats then can introduce, on New Year's Day, a new tax bill lowering rates for 98% of Americans. That allows them to pull off the political coup of transforming "Bush-era" tax cuts into "Obama-era" tax cuts. And that would put the Republicans in the awkward position of voting against a tax cut for 98% of taxpayers. They could not survive that.

Of course, that means we all pay higher taxes for three or four months until a new tax bill gets passed. But it's safe to assume that politicians are savvy enough to make such a tax bill retroactive to the first of the year so that higher winter taxes will come back to taxpayers in the spring. The economic recovery can withstand that.

The recovery also can withstand a tax increase on the wealthiest 2%, who can pretty much kiss goodbye their lower tax rate of 35% as it goes to 39.6%.

Despite the economic fantasies of Ayn Rand, a marginal tax increase on this group is economically insignificant. Mercedes-Benz car dealerships may have a rough go, but Ford, Chevy and Honda dealers will be safe.

In the end, a marginal tax increase on the top 2% of income earners will have little negative impact on the overall economy, but it also will have little positive impact on reducing the federal deficit. The battle over the top 2% has really become a symbolic gesture in the ongoing war between Democrats and Republicans.

Summing up the higher-tax side of the fiscal-cliff scenario, all the negative projections assume the higher taxes are permanent. That can't happen. Any political party left holding that bag would be obliterated in the midterm elections. There could very well be a short-term disruption on the tax side, but short-term disruptions should not derail the recovery.

Now, how about the other side of the fiscal-cliff scenario: massive cuts in spending. Anyone who has followed the political debates over the past few years knows that spending cuts are coming one way or the other. Congress has clearly stated its intention to cut spending; it is just a matter of where and how much.

So, why all the hand-wringing over sequestration, the term used for the automatic cuts? It does not seem to be a political option to hold off spending cuts until the recovery is on firmer footing, not when so many believe austerity is the key to recovery.

The mandated sequestration is not so much a cliff as a steep slope, with cuts being phased in over time. But "fiscal slope" just does not have the same ring to it as "fiscal cliff."

Of course, sequestration will hurt the recovery by taking money out of the economy when it should be putting it in to support employment. However, that does not appear to be an option with austerity economics calling the shots.

The beauty of sequestration is that it is fair and even-handed, like blind justice. Everyone pays the same price: across-the-board cuts of 8% for non-defense line items and 9% for defense programs.

That will really hurt, but will it hurt more than the deep but unbalanced cuts some are proposing?

In its defense, sequestration is simple, a done deal that avoids political gridlock and forestalls arguments against raising the debt-limit ceiling, which is the real "cliff" we should be worried about. Perhaps going over this fiscal cliff will knock some sense into Washington.

Timothy Grogan is a senior economics editor for McGraw-Hill Construction Analytics. He holds a master's degree in economics from the New School for Social Research.

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