What Congress Should Do With the Fiscal Cliff

With a large number of policies set to expire or kick in at the end of the year, with serious fiscal impacts, CRFB has released a paper laying out the optimal path for policymakers to take to avoid both a short-term economic hit from the fiscal cliff and the long-term economic consequences of not dealing with our rising debt. The solution? You guessed it -- making smart, gradual, and targeted reforms to the key drivers of our debt.

For background, there are a litany of policies that are scheduled to expire or kick in at the end of the year (and some policies that have already expired but could be extended retroactively). The ten-year cost of extending these policies could total about $7.5 trillion. They include:

• The expiration of the 2001/2003/2010 tax cuts
• The expiration of AMT patches
• The expiration of the temporary payroll tax holiday
• The expiration of expanded unemployment benefits
• The expiration of the doc fix
• The activation of the sequester
• The expiration of other various tax provisions

Obviously, extending these policies would have enormous negative consequences for our fiscal situation. Debt would be about 30 percentage points of GDP higher in 2022 compared to current law if they were all extended. At the same time, all of these policies hitting all at one time when the economy has not fully recovered is not very good short-term policy.

^{*Assumes a one year extension
^Excludes bonus depreciation and expensing rules}

Achieving something similar to the savings already scheduled under current law would be great from a fiscal policy perspective, and we would hope to get there. However, as Federal Reserve chairman Ben Bernanke has said, "it is important to achieve sustainability over a longer period...one day is a pretty short time frame." In addition, many of these policies are designed in a way that is not conducive to growth unintended consequences. Still, this should not be an excuse to deficit-finance all of these extensions, which would be the worst scenario possible.

A better path would be one that gets the timing of deficit reduction right while enacting policies that are generally more conducive to growth than current law. In other words, we need a deficit reduction path that looks like current law, but more phased in and with much more thought-out policies. This type of path is embodied in prominent bipartisan fiscal plans, such as the Simpson-Bowles and Domenici-Rivlin recommendations, which generally held off on short-term cuts (Domenici-Rivlin, in fact, included stimulus) and implemented pro-growth policies like comprehensive tax reform. 

Let's hope that policymakers choose the gradual path and avoid the fiscal cliff and mountain of debt. Click here to read more about the opportunity that lawmakers have this year.