To read the headlines, the American economy was saved when Congress narrowly passed legislation "averting" the fiscal cliff on January 1, and the president signed it 24 hours later. However, all is not well with the compromise deal. On the left, progressives are upset that President Obama didn't push for more revenue. On the right, conservatives are furious that taxes went up on most Americans--the Bush tax cuts ended for individuals making over $400,000 a year (and families with income in excess of $450,000), while the 2 percent payroll tax break went away for everyone.
But very few seem to be upset about the one thing Democrats and Republicans agreed on: delaying the $1.2 trillion in Budget Control Act spending cuts.
There are a lot of problems with the tax changes that Congress agreed to, but what is most striking is how the biggest issue--our desperate need to cut federal spending--was ignored in the fiscal cliff negotiations. In fact, we've gone backwards on addressing spending, as the compromise deal involved delaying a pending $100 billion in spending cuts for two months while lawmakers find another way to kick the can down the road. A bit more revenue--whether the $600 billion President Obama got or the $1.6 trillion he wanted--is not going to fix the budget, only substantive reductions in federal outlays will. Here is a chart to show you the trends:
All of the political language around the fiscal cliff spending cuts assumed they would be catastrophic. In fact, the only really bad part of the fiscal cliff was taxes going up, which tends to suck money out of the economy. In the summer of 2011, Congress agreed to $1.2 trillion in budget cuts across the board to be spread out over 10 years (aka the Budget Control Act). In exchange, Congress raised the federal debt ceiling by a similar amount. Those cuts were delayed to start until January 1, 2013, so the cuts that were so feared were actually something agreed upon years ago.
Moreover, the difference between a budget with the $1.2 trillion in cuts or without is pretty marginal. In the graph above the dark blue area shows the Congressional Budget Office's projection of federal spending including the $1.2 trillion in cuts. The dotted line represents what federal spending would look like if there were no cuts at all. Finally, the solid orange line estimates spending with the budget cuts delayed for two months. Notice that postponing the "catastrophic" spending cuts hardly differs from the baseline. And when Congress gets back around to avoiding the cuts in February they should realize that in context of the larger need to cut spending, $1.2 trillion is not that much--though it does move the ball forward.
Even if the $1.2 trillion in cuts kick in on March 1st we'll still be well beyond responsible spending. In a late December article we highlighted the massive growth in federal spending just over the past decade. Assume for a moment that Congress froze all federal spending in 2002 and just increased outlays to adjust for population growth (so spending per person would remain the same). Under this fantasy scenario, federal spending would have grown from $2 trillion to $2.27 trillion by 2012. This growth is represented in the light blue area at the bottom of the graph. Compare that to the dark blue area above it representing what the government actually spent from 2002 to 2012. Even adjusting for inflation, by the end of last year we were spending 41 percent more per person than in 2002!
It is true that the federal deficit is larger today because the recession-weakened economy meant lower tax returns. However during that time, rather than responsibly tightening congressional budgets, spending kept increasing in inflation adjusted dollars and has remained excessively high above the growth rate we could have expected by just keeping federal programs at 2002 levels.
The whole narrative of the fiscal cliff was that somehow the economy was on the edge of disaster, when in fact all Washington had done was drive us to the edge of a manufactured crisis. Raising taxes will be damaging to the economy, but cutting spending will help growth in the long-term. Not only do we need to reign in the deficit, but we need to reduce the size of federal spending overall. The fiscal cliff deal added nearly $4 trillion to the deficit and avoided spending cuts, precisely the wrong thing to do.