So how steep is that fiscal cliff?

John Cochrane reckons the US government is doing the usual:

There are no “cuts” in sight anyway. “Cut” in Washington means “increase spending less than we previously said we would.” At worst a few programs will have to spend the same amount this year as last before spending increases resume.

That would be my expectation – but no. It seems there might actually be some spending cuts. Bob Murphy had a look at CBO data.

We are already in Fiscal Year 2013; it started on October 1. So the column for 2012 is already done; the changes (if no deal is reached) will show up in the 2013 numbers.
So: If nothing is done and we go over the “cliff,” then total spending will drop from $3.563 trillion to $3.554 trillion, a reduction of $9 billion, or 0.3%. Notice everyone, I am saying a drop of three-tenths of one percent. Then, by 2014, total spending will have risen to above where it was this year, in 2012 (because 3,595 > 3,563).
On the revenue side, going over the “cliff” is projected to raise receipts from $2.435 trillion in 2012 to $2.913 trillion in 2013, an increase of $478 billion, or 19.6%.

So the decrease in the US deficit is being driven by tax increases not reduced spending.

Is that a problem? After all a whole bunch of people reckons that it doesn’t matter if you reduce the deficit by increased taxation or reduced spending (or some combination). Well, Cochrane explains:

To an economist, the main worry is that higher marginal tax rates mean more distortions, which are a drag on the economy. But distortions take a while to kick in. It takes a while for people to change to easier jobs, not start businesses, move businesses offshore, not go to school, choose easier but less rewarding majors, find more tax shelters, and so on. So the danger is not so much a recession, which comes, and then ends, and we go back to growth. The danger is settling in to a decade of (even more) high-distortion, sclerotic growth.

Cochrane isn’t worried about recession – he is worried about long-term distortions induced by poor government policy.

How terrible will it be if we go over the cliff?

Bad, but for all the wrong reasons. If you, like me, didn’t think that “stimulus” from government spending raised GDP in the recession, you can’t complain that less government spending will cause a new recession now. The CBO’s projections of recession are entirely Keynesian. Pay them heed if you still think the key to prosperity is for the government to borrow money and blow it.

Overall that cliff isn’t too steep. Tax increases are bad policy. The proposed spending cuts are not nearly enough.

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24 Responses to So how steep is that fiscal cliff?

  1. stackja

    Obama’s supporters expect the entitlements they voted for. The ‘rich’ can always provide more.

  2. Chris

    Cochrane isn’t worried about recession – he is worried about long-term distortions induced by poor government policy

    Does that mean that going over the fiscal cliff could end up being a good real world test of who is right since he believes the problems are long term rather than short? If there’s a recession in 2013 then the Keynsian’s are right, if not then they’re wrong?

  3. If you, like me, didn’t think that “stimulus” from government spending raised GDP in the recession, you can’t complain that less government spending will cause a new recession now.

    I’m missing something…

    If smashing more windows didn’t produce more value then not increasing the rate of smashing won’t reduce the value of production?

    Technically correct but it’s not the point.

    Cutting funding to the ALPBC would increase real Australian value production by $1 Billion.

  4. Ellen of Tasmania

    The fiscal cliff step that they are too scared to take. The fiscal mega-cliff that they are brazenly creating.

  5. Gab

    You shouldn’t be worrying about the fiscal cliff..Be like Obama and just play golf.

  6. Rafe

    Mario Rizzo, an Austrian and classical liberal has a non-standard take, let all the taxpayers feel the cost of irresponsible spending.

    Not sure that I agree, but interesting.

    The problem is to get the non-taxpayers to care about unsustainable spending.

    How come the people who have sustainability as a mantra don’t apply that thinking to spending?

  7. m0nty

    If you, like me, didn’t think that “stimulus” from government spending raised GDP in the recession, you can’t complain that less government spending will cause a new recession now. The CBO’s projections of recession are entirely Keynesian. Pay them heed if you still think the key to prosperity is for the government to borrow money and blow it.

    This is an excellent point, but I wonder how many Tea Partiers actually grok it. Would they really push the US over the cliff to prove a point about cyclical theory? And if the US does go into recession as a result, wouldn’t that make them look like deluded fools?

  8. Chris M

    Rafe – I agree with Mario Rizzo also. Similarly in Australia I would suggest an Abbott government should not pay down the debt (but don’t add to it) as the residual debt will at least put some small limitation on Labor next time they are in. Like in QLD currently the Libs always get blamed for the pain fixing Labors mess.

  9. Johno

    Like Australa, the US needs to close the fiscal deficit. Based on Murphy’s numbers the US is doing it the wrong way, with higher taxes doing all of the heavy lifting. Taxes should by kept where they are, while spending is cut.

    The current noise in Australa about increasing the GST rate to help fund the States should be rejected. State governments have to live within their means. No more money for them, they need to cut heir spending.

  10. entropy


    Rafe – I agree with Mario Rizzo also. Similarly in Australia I would suggest an Abbott government should not pay down the debt (but don’t add to it) as the residual debt will at least put some small limitation on Labor next time they are in. Like in QLD currently the Libs always get blamed for the pain fixing Labors mess.


    agree. Put all the debt in a single account called ‘labor’s debt’. And leave it there for next time. The few bill a year in interest will serve as a reminder of what the ALP has wrought.

  11. Simon

    @Johno
    The problem is not them living within their means mate it that they have the capacity to raise revenues in the most detrimental and short sighted of ways. Everytime they want to capture some funds everything for everyone else becomes more onerous and time consuming, for example speeding fines and the deliberate slowing of arterial roadways to get them, new housing administration charges/levies and health and education cutbacks. I’m all for an increase in GST provided that the states lose all right to impose fees, fines, charges, levies, imposts and royalties. Otherwise it is just another cross to bare for the enitre country.

  12. Crossie

    Abbott government should not pay down the debt (but don’t add to it) as the residual debt will at least put some small limitation on Labor next time they are in.

    I agree with this very sensible suggestion. Every Liberal government in living memory inherited a dismal financial situation from the preceding Labor government and dutifully went about paying it off. Then they were promptly punished for it at the ballot box.

    Let the rusted-on Labor voters be reminded at each election what their party does when in power.

  13. What bollocks. Keynes’ assumption that increasing govt spending increases GDP is akin to CO2 being a greenhouse gas. It is no more a validation of his reasoning to spend your way out of recession than taxing CO2 production is to reduce global warming.

    Avoiding recessions are short-term solutions with long-term consequences. They are a natural part of the economic cycle and “stopping” them just causes economy-destroying debt like we now have. Instead of periodic recessions we will just have one – the mother of all recessions that could make the depression look like the day before payday.

  14. “I agree with this very sensible suggestion.”

    I agree with this too. A $1billion surplus each year will look like it was done just to show Labor how easy it really is if you just try. All criticisms will be easily brushed off as “you couldn’t do it – ever”.

  15. 2dogs

    “the residual debt will at least put some small limitation on Labor next time they are in”

    Don’t count on it. This needs constitutional reform.

  16. Alice

    Tax increases are good policy for some and I think everyone knows who the some are.
    Im just waiting for peoplke top get smart enough to realise when they are being conned into thinking tax increases are bad policy (only when they ae increased on the ones who have been suffering inequality – which is the bottom 95% I would hazard a guess).

    As for the top 5% – They could do better than to cough up, shut up and stop buying media time to convince the rest of us suckers that they need a tax break.

    Pass the vomit bowl.

  17. Alice

    And no I dont want to know how many more government services people plan to cut to make it easier for the top 5% to live within their means.

    What a crock of crap and it all gets spouted out somewhere by the disty digger’s news (friend to the already rich).

    Pass the vomit bowl again. Is Rupert Murdoch (Australkian at that – what shame that we produced someone like that) old enough that he will just keel over soon?

    I hope so. I think his kids have no respect for him.

  18. Splatacrobat

    On the turps again?

  19. Chris M

    2dogs, oh totally – the emphasis was on ‘small’ and the point was there is little point in doing the sensible thing and paying down debt in this climate.

  20. Pickles

    No. Pay off the debt. No good pointing at the mess and yelling “it’s not my mess” at it. It’s part of political life to shovel up Labors shit when you move in.

  21. Alice

    Is it true that the US republicans in power are holding out on the majority of conservatives in the US by seeking to protect the top wealthy 2% from cuts and so enforce tax rises on the majority in their own party?

    Thats whats all over the news.

    If that is the case? – they have been bought and watch the buyers buy the other side when they fall.

    Who is really doing the buying of politicians votes here because I am sure a lot of the wealthy wouldn’t even mind paying more tax (or are we talking wealthy comglomerates doing the political donating who were never natural people anyway).

    It seems to late to keep their lobbying/ buying power at length doesnt it?

  22. Mk50 of Brisbane

    MAlice the Sot:

    As for the top 5% – They could do better than to cough up, shut up and stop buying media time to convince the rest of us suckers that they need a tax break.

    Hmm. MAlice the Sot is a perennial lair, so this needs checking. What does the ATO say, then?

    Percentile % Income earned % tax paid
    Top 1 9.4 16.5
    Top 5 20.8 32.3

    What a surprise. MAlice the Sot is lying again. Turns out the top 5% of earners earn 20.8% of the income and pay 32.3% of the tax.

    Our pet soak reckons that this is them ‘not paying their fair share’.

  23. Tax increases are bad policy

    Depends how this is defined. Some seem to consider removing stupid deductions or exemptions as a tax increase. Then we can consider is the tax rate as a percentage of GDP a tax increase. With a good economy the tax take will naturally increase.

    So tax increases are not always bad policy and must be looked at on a case by case basis. If I can find anyone who would not support an increase in the GST I would be surprised.

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