The sequestration mandated by the Budget Control Act of 2011 and the reversal of the Bush-era and payroll tax cuts would essentially mean withdrawing from the economy some 4 percent of the national income in one blunt go — and this doesn’t factor in possible knock-on effects. The importance of this issue cannot be overstated. A fiscal contraction of this magnitude and composition would stop dead in its tracks the economy’s nascent healing and job creation. Consumption and investment would be harmed. Foreigners would become more cautious about buying our ever-increasing debt issuance. And with our internal growth momentum weakened, the headwinds from the European debt crisis could prove overwhelming.
As opposed to such a disorderly big bang, the U.S. fiscal situation requires a carefully designed and well-timed overhaul to make government finances more efficient and fairer — among other things, combining immediate stimulus with a credible set of medium-term tax and entitlement reforms and a sustainable effort to reduce the deficit over time. But rather than addressing our fiscal challenges with a scalpel, America is reaching for a blunt ax that is likely to do more harm than good. Indeed, several items set for implementation at the end of 2012 would impede further economic growth, job creation and medium-term financial stability. Some measures — including cuts to education programs and teaching jobs when our educational system is already under tremendous pressure — would go even further, causing inconsistencies between spending priorities and, in some cases, creating pockets of operational paralysis.
The worries do not stop here. Never mind that it has been less than a year since the last political circus over the debt ceiling caused an economic slowdown, fueled concerns about a double-dip recession and contributed to Standard & Poor’s downgrading the United States’ sacred triple-A credit rating. Just as few in Washington presumed last year that things would reach that point, few think the fiscal cliff will materialize. After all, the deadline was always meant to act as a catalyst for serious revenue and expenditure reforms — including revamping the federal tax code, streamlining entitlements and realigning incentives to favor production and investment rather than consumption and operational avoidance of U.S. tax jurisdictions. But complacency has continued to reign, leaving the country exposed to unnecessary economic trauma and renewed political dysfunction.
Markets are discounters of the future, and prolonged political inaction is likely to encourage companies to postpone building plants and purchasing equipment and to discourage them from hiring.
All this speaks to the importance of acting now to avoid getting too close to the cliff’s edge. The good news is that quite a bit of technical work has been done in Washington on proper fiscal reform, along with background scenario analyses. Also, I suspect that, in their hearts, most politicians from both sides of the aisle recognize that progress necessitates a series of confidence-building compromises that are in the nation’s interest.