Now that the fiscal cliff deal is law, let’s look at its impact on the federal budget, national debt and economy.
Measuring the budgetary impact of the fiscal cliff deal is a matter of perspective. Viewing it one way, the deal reduces the deficit a small amount, viewed another, it adds considerably to the deficit. There are two basic baselines used to measure the cost of legislation. The official baseline that the Congressional Budget Office (CBO) must use in estimating costs is “Current Law.” Before President Obama signed the fiscal cliff deal the law had all the tax cuts expiring at the end of 2012. Because the deal extended almost all the tax cuts, the Current Law baseline says it will cost $4.6 trillion over the next decade. On the other hand, the “Current Policy” baseline assumes that policies in effect will carry on, even if the law says they won’t. In this scenario the deal saves $650 billion over ten years because the tax cuts for families earning over $450,000 were not extended.
Naturally, how one measures the cost of the deal also affects how it impacts the national debt. Under Current Law, public debt (not including money the government owes itself) will be 73% of the economy as measured by Gross Domestic Product (GDP) in ten years, about where it is now. However, a Current Policy baseline from the Committee for a Responsible Federal Budget (CRFB), which assumes that the sequester never takes effect, reductions in Medicare payments to physicians continue to be put off (the so-called “doc fix”), as well as a few other assumptions differing from what Current Law says, puts public debt at 79% of the economy in 2022. Both of these estimates are much higher than the post-World War II average, which is closer to 40% of GDP.
The long-term debt picture is even worse, with the Current Law baseline reaching above 100% of the economy by 2052 and the CRFB baseline exceeding 300% of GDP by 2052. The long-term debt is clearly on an unsustainable course.
When it comes to short-term economic effects, the deal mitigates, but does not completely abate the drag on the economy this year. The estimated drag on growth is now 1.3% of GDP as opposed to nearly 3% before the deal. Much of the rest of the economic effect is attributed to the across-the-board spending cuts known as “sequestration.”
The deal put off the sequester for two months, meaning lawmakers will soon have to deal with sharp cuts to defense and domestic spending that both sides view as unpalatable. Replacing the sequester with a comprehensive deal that puts the debt on a downward path over the long run is the best way to fix the debt without damaging the economy.
No matter how you look at the fiscal cliff deal, more has to be done to address the national debt and there will be more opportunities to do so. A bipartisan comprehensive plan is the only way to avoid more cliffs down the road.