Fiscal Cliff Won’t be All Bad

For the 32nd consecutive year, The University of Alabama’s Office of Media Relations offers predictions from faculty experts for the coming year.

Fasten your seat belt, says Dr. Paul Drnevich, an associate professor of strategic management at The University of Alabama,“because we will likely go over the ‘fiscal cliff’ in some capacity in early 2013.”

But, says Drnevich, “It wouldn’t really be all that bad to do so.”

“Fiscal cliff” is the term used to describe the problem the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.

Among the laws set to change are the end of last year’s temporary payroll tax cuts (resulting in a 2 percent tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would take a larger bite, the end of the tax cuts from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect.

As Drnevich explains it, going over the “fiscal cliff” would not be a bad as most fear and likely be a net positive in the longer term for the U.S. economy for several reasons.

First, the budget sequestration (or automatic spending cuts) would force real cuts in federal spending. With federal spending up roughly 50 percent since 2008 levels, currently running at roughly 150 percent of tax revenue receipts ($1.50 spent for every $1 collected), and projected to increase further for each of the next 10 years, this current and projected path is not sustainable and will lead to further inflation, increased unemployment, and reduced credit ratings for the government, Drnevich says.

So, while perceived as a negative signal by the markets and media, accomplishing “real” reductions in federal spending would signal a “turning of the tide” and a path toward fiscal responsibility and back to solvency, he says.

Secondly, the elimination of the “Bush tax cuts” would in effect raise taxes on everyone, not just the top 1 or 2 percent. Also, while these tax increases are perceived by the markets and the media as negative, they will have positive effects in that they will require a higher portion of the population to pay federal income taxes than does so currently and will increase the amount of revenue collected by the government.

Increasing the participation rate will increase labor productivity and decrease unemployment, Drnevich says. The increased tax revenues, combined with the budget sequestration cuts, will help to narrow the trillion dollar plus annual budget deficits, creating more capital for business, signaling stability, and increasing economic growth.

Any deal to avoid going over the fiscal cliff would be bad despite opinions and claims to the contrary, Drnevich says. Avoiding the cliff, while being perceived as positive by the markets and media, will be disadvantageous for the U.S. economy, Drnevich says, as it would avoid and delay corrections necessary to return the government to fiscal responsibility and the economy to stability.

Without real reductions in spending coupled with increases in tax receipts in the coming year, the U.S. economy will be in much worse shape in 2014-2016, Drnevich says. Real unemployment will increase, underemployment will increase, food and fuel costs will increase, and the national debt will exceed $20 trillion and remain well over 100 percent of Gross Domestic Product, he predicts.