How Congress Should Avert the Fiscal Cliff

As the economy teeters precariously on the edge of the so-called “fiscal cliff,” it is difficult not to imagine what advice Milton Friedman, the brilliant economist and staunch advocate of limited government and fiscal restraint, would have offered our nation’s lawmakers had he lived to celebrate his hundredth birthday.

For those not fluent in wonk jargon, the “fiscal cliff” refers to a farrago of tax increases and mandatory spending cuts that are scheduled to take effect at the end of this year. The scheduled changes include the expiration of the 2001, 2003, and 2010 tax cuts; an expansion of the Alternative Minimum Tax; the expiration of the two percent payroll tax holiday; the expiration of expanded unemployment benefits; the expiration of doc fixes for Medicare providers; and the expiration of various tax extenders, like the research and development tax credit. The spending sequester would reduce spending on Medicare, defense, and nondefense discretionary programs by approximately $65 billion in FY 2013 and $980 billion over the next decade.

The Congressional Budget Office (CBO) is warning that, should Congress fail to avert the cliff, the economy may plunge into another recession. According to CBO estimates, if the fiscal cliff’s provisions are allowed to take effect, they will reduce GDP growth next year by 3.9 percent. The CBO has calculated that the tax cut expirations alone will reduce the size of the economy in FY 2013 by about two percent and will increase unemployment by approximately one percent. Nonetheless, lawmakers have so far been too busy hand-wringing and posturing to avert the looming crisis.

Democrats, at least according to Sen. Patty Murray (D-Wa.), are willing to let the Bush-era tax cuts expire for everybody, lest the government be precluded from imposing punitive rates on individuals earning more than $200,000 a year and households earning more than $250,000 a year. Meanwhile, Republicans are bemoaning the specter of a defense sequestration under which the Pentagon’s inflation-adjusted 2013 base budget would still exceed its base budget for 2006.

Policymakers who argue that higher taxes are needed to reduce our nation’s fiscal deficit should heed the advice of Friedman, who once stated, “Higher taxes never reduce the deficit. Governments spend whatever they take in and then whatever they can get away with.” Increasing taxes by letting current rates expire will not get our fiscal house in order; it will merely give Congress an implicit free license to continue on its prodigal spending spree.

On the other hand, lawmakers who fear the $1.2 trillion in automatic spending cuts set to take effect over the next decade should bear in mind that this amount constitutes a mere 2.6% of the administration’s projected outlays over that same time period. Considering that the federal government amassed a $1.2 trillion deficit in FY 2012 alone, allowing the scheduled cuts to take effect seems like a reasonable way to limit the growth of government spending over the next decade.

As our nation stares down the barrel of a gun loaded with a $16 trillion debt, trillions more in unfunded liabilities, a possible third round of quantitative easing, an impending debt ceiling debate, and a healthcare law rife with regulations and tax hikes, we should urge our lawmakers to embrace a policy compromise that will avert a recession in the short run and facilitate economic growth in the long run.

Were we living in an alternative universe, one might suggest that Congress limit the size and scope of government and substitute a simple, flat rate for the labyrinthine, Kafkaesque morass otherwise known as our internal revenue code. Given the confines of political reality, however, a relatively moderate reduction in spending, coupled with tax cut extensions for all taxpayers, seems like a smart way to encourage long-run fiscal restraint without sending our economy toppling over a cliff.

  — Madeline Eldridge