The start of 2013 may turn out to be far less bleak than feared. For one thing, the two sides may strike a short-term agreement before New Year’s that postpones spending cuts until spring. Even if no deal is struck before the end of the year, businesses and consumers would not likely panic as long as some agreement seemed imminent. The tax increases and spending cuts could be retroactively repealed. And the impact of the tax increases would be felt only gradually. Most people would receive slightly less money in each paycheck.
“The simple conclusion that going off the cliff necessarily means a recession next year is wrong,” says Lewis Alexander, an economist at Nomura Securities. “It will ultimately depend on how long the policies are in place.”
But prospect of permanent tax increases and spending cuts could cause many consumers and businesses to delay spending, hiring or expanding. So what this all means is that the US economy will shrink 0.5% in the first half of 2013 and fall into recession, the Congressional Budget Office estimates.
Here are a few reasons why a tumble wouldn’t hurt us much:
Though the fiscal cliff would cost the economy an estimated $671 billion for all of 2013, the tax hit for most people would be slight at first. The expiration of Social Security and income tax cuts would be spread throughout 2013. For taxpayers with incomes of $40,000 to $65,000, paychecks would shrink an average of about $1,500 next year but an average of just $130 in January, according to the nonpartisan Tax Policy Center.
And 1/3 of the tax increases wouldn’t touch most Americans. Some would hit businesses. Others, such as higher taxes on investment income and estates, and the expiration of middle-income tax credits, wouldn’t come due until Americans filed their 2013 taxes in 2014.
Also the IRS has delayed any increases in tax withholding that would otherwise kick in. Without a deal, the top income tax rate for single people with taxable income between about $36,000 and $88,000 would rise from 25 percent to 28 percent. But that won’t start to reduce Americans’ paychecks in early January, even if no deal is reached by then.
(Remember, this can all be repealed, so don’t panic).
About $85 billion in spending cuts to defense and domestic programs would take weeks or longer to take effect. That means government agencies wouldn’t cut jobs right away. Yet even if they agree to a short term deal, taxes will still go up slightly.
A tumble also would mean unemployment would end for $2 million people. The federal government’s program pays for about 32 weeks of extra benefits, on average, on top of the 26 weeks most states provide. Weekly unemployment checks average about $320 nationwide. And that doesn’t keep the bills paid. Time for Obama to cough up those jobs he promised.
Sure the stock market will drop, but like before, it will climb back. The expiration of the Social Security tax cut and the end of emergency unemployment benefits would likely shave 0.7 percentage point off economic growth next year, the CBO estimates. The economy is now growing at about a 2 percent annual pace.
Higher taxes would hit poorer people particularly hard. That’s partly because many tax cuts and credits aimed at lower-income households would end. Even modest tax increases take a bigger toll on those with less income to begin with. For a married couple with an income between $20,000 and $30,000, taxes would rise $1,423 next year, according to the Tax Policy Center.
The economy would shrink at an annual rate of 0.6 percent in the first three months of 2013, estimates Joel Prakken, an economist at Macroeconomic Advisors. That compares with an estimated 1.9 percent growth rate if a deal is reached. CBO forecasts that the unemployment rate would rise to 9.1 percent from the current 7.7 percent.
Last week, Obama and House Speaker John Boehner narrowed their differences on income tax increases and spending cuts.
Whatever the outcome, some trends could offset part of the economic damage. The average retail price for gasoline has dropped 15 percent this fall, for example. Lower gas prices give consumers more money to spend elsewhere.