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Government & Politics

Your Guide to the Fiscal Cliff Debate

By Lauren Ober

artist's cartoon rendering of fiscal cliff

The fiscal cliff debate in Washington continues as a critical deadline looms. Politicians are locked in tense negotiations with pressure to hammer out a deal to bring taxes and spending in check.

Assuming no agreement is reached, about $500 billion in tax increases and $100 billion in automatic spending cuts are set to take effect in January, according to the Economic Policy Institute.

But Evan Kraft, economist-in-residence at AU, doesn’t think we’ll go over the cliff. If we did, he said, the effects wouldn’t be felt immediately. AU sat down with Kraft to talk about the debate, why it matters and what the average citizen can do about it:

AU: What happens after January 1 if an agreement hasn’t been reached?

EK: If politicians fail to agree on anything, something truly unpalatable will happen that both parties will really not like. That was the idea — to make the consequences of inaction so horrible that they will be forced to act. They wanted to make this something that both sides want to avoid it so badly they’ll actually be forced to compromise.

AU: Do you think the term “fiscal cliff” is appropriate?

EK: No. I think it really isn’t that great a metaphor because if they don’t reach agreement and these measures actually go into effect, the consequences won’t be immediate. Some of the repercussions will go into effect immediately. And some of the other consequences take longer. It’s rather more gradual.

AU: What are the short-term implications?

EK: People will face higher payroll taxes, which all employed Americans would feel in their next paychecks. So there would be a tax increase. Obviously President Obama has proposed only allowing the cuts to lapse on the highest incomes. But that will not throw the economy into an immediate recession in a month.

AU: And the longer-term implications?

EK: Some of the drastic military spending cuts would result in the closing of some facilities and people losing jobs. That would take place over time.

Going a little deeper, I think there are serious issues that have to be acknowledged. The deficit has increased rapidly. I would not be so troubled by that if I didn’t know Social Security and health care are poised to cause serious fiscal issues. I think Social Security is quite fixable, but health care is far more difficult to repair.

AU: What can be done about that?

EK: I think more sober analyses suggest that the U.S. will need to make some significant changes in both taxation and spending policies in order to keep the fiscal deficit at a reasonable level from about 2020 on. So in other words, the crisis isn’t really on us today.

AU: What if politicians cannot reach a deal?

EK: If there were no new legislative measures taken, the result would be drastic over a period of six months to a year. Then it would certainly set the economy back. The estimates that it could bring us back into recession are reasonable. But that assumes Congress doesn’t do anything to offset this.

AU: Would Congress let that happen?

EK: I think when both sides feel like it, they make the correct point that any extreme fiscal adjustment — drastic increase in taxes or decrease in spending — at this point given how fragile the economy is and how recent and incomplete our recovery is from this tremendous economics disaster, is unwise. We are simply not in a position to make drastic changes right now.

AU: How did we get to this place?

EK: I honestly think it is part of the political process. It was clear that neither party was willing to give in with significant concessions until the election results were in because they hoped it would be an affirmation of their position. So it would be unrealistic given the way the whole thing was set up to expect them to really do much until the elections happened. Inherently, it was a stay up late and cram situation.

AU: Are we in a time of crisis?

EK: There’s certainly been a lot of what I would call overheated discussion of the imminence of a fiscal crisis. The best way to tell whether the U.S. is in big trouble is to look at the interest rate that creditors charge us to borrow money. Currently, the U.S. government is able to borrow at incredibly low interest rates that we haven’t seen since the 1950s or 60s. It’s a sign that creditors don’t see the U.S. as a risk. When our government says that certain financial obligations have the full faith and credit of the U.S. behind it that still means a lot. So from that perspective, one could say that there is really no immediate evidence of a crisis.

AU: Is there anything the average person can do about this?

EK: If citizens understand what’s at stake, they can very effectively communicate with their representatives in Congress and express their preferences. Some citizens may be more worried about particular programs that are threatened, or particular taxes that might hit them. I absolutely think this is a very important time for people to speak out.