Fiscal Cliff Deal: What It Means for the Economy
Policy + Politics

Fiscal Cliff Deal: What It Means for the Economy


Wall Street analysts responded to the fiscal cliff deal with a mix of optimism and disappointment. The deal, which raises tax rates on the rich and allows the two-year payroll tax holiday to expire, won’t cripple the economy, they largely agree, but it also won’t do much to unleash stronger growth this year and beyond – and it still leaves businesses, consumers and investors faced with plenty of uncertainty.

Here, a round-up of economists’ reactions to the fiscal cliff deal.

Mohamed El-Erian, Pimco
On the positive side, the compromise averts a mix of tax increases and spending cuts that would have done more harm than just push the nation into another recession. It would have also seriously undermined the hard-earned healing occurring in the housing sector and in many families' stretched balance sheets. With that, our economy would have experienced a significant air pocket, and would have faced an even more difficult subsequent recovery.

As important as this gain is, it is unfortunately not overwhelming. The hard-negotiated political compromise does little to address the consistent headwinds that undermine growth, hold back corporate investment, and dampen job creation. If the objective were to promote employment, the nation’s most urgent challenge, the compromise prolongs crippling political uncertainty rather than removes it....

By increasing tax rates on better off segments and by maintaining redistribution mechanisms, an effort is being made to stop years of steady deterioration in income and wealth inequalities. Yet the benefits will only prove durable and meaningful if the nation's overall economic context is addressed in a more comprehensive manner that improves economic growth and creates jobs. For that, we need a much more visionary, responsible and functional Congress.

Jim O’Sullivan, High Frequency Economics
We have allowed for a 0.2-point hit to 2013 growth from the sequester-related spending cuts — and a 1.1-point drag from all the items listed. Fiscal drag of just over one point on growth is sizable. However … the new fiscal drag will largely just replace the old fiscal drag. The unwinding of the 2009 stimulus package and state and local budget cuts have been subtracting about a point from growth recently, but those sources of drag are now fading. For the year as a whole at least, fiscal drag is not likely to be significantly larger than it was in 2012; it is not a reason to expect 2013 to be weaker than 2012.

David Kelly, J.P. Morgan Funds
First, because the fight was concentrated on how the “rich” should be taxed, many investors may have the impression that this was a relatively small and narrowly focused tax increase. In fact, this represents a very significant increase in taxation on almost all Americans, with the most pain likely being inflicted by the expiration of the 2% payroll tax cut. From a macro-economic perspective, this is also where the impact is likely to be greatest – consumer spending on basic goods and services like groceries, clothing, restaurant meals and gasoline should all take a hit over the next few months due to lower take-home pay. 

Second, there is the impression that this deal is somehow “kicking the can down the road”. It is, to an extent, from a political perspective, as a new debt-ceiling debate looms in two months. However, this tax increase will make a big dent in the deficit. Assuming that some other spending cuts more or less replace the much-hated sequester, it could cause the deficit to fall from 7.0% of GDP in fiscal 2012 to 5.8% of GDP in fiscal 2013 and 4.2% in 2014. In fiscal 2009, the deficit was over 10% of GDP. Once it falls below 4.0% of GDP the debt/GDP ratio should begin to fall, bringing some stability to federal finances. Overall, we are not that far from that goal and last night’s vote was an important, if somewhat too large, step in that direction. Finally, the impact of all of this should be to slow the U.S. economy in the first half of 2013 but not put it into recession.

Ed Yardeni, Yardeni Research
[We] are sticking with our forecast of 2.0%-2.5% real GDP growth during the first half of this year. Actually, we expect some fiscal lift because nearly all Americans will be relieved to learn this morning that Congress has permanently lowered their taxes. That should boost consumer confidence and spending. If the stock market continues to rally, as I expect, even rich folks facing higher taxes will be happy to see their equity portfolios appreciate. While many of our competitors have been nearly hysterical about the downside of the fiscal cliff, I have consistently argued that averting the fiscal cliff was likely and might actually be very stimulative. Indeed, the economy was showing some good forward momentum late last year that should also help to overcome the fiscal drag resulting from the deal to avert the cliff…

Scott Wren, Wells Fargo Advisors
Based on the results of the “fiscal cliff” negotiations, taxes are going up on everybody that holds a job since the Social Security payroll tax returns to the previous 6.2% rate from last year’s 4.2%. So the vast majority of Americans will see less money in their paychecks this year, all else being equal. Any decisions involving potential spending cuts have been out off for two months. We do not believe the effects on the economy will be substantial at this point but the debate on the debt ceiling promises to be quite contentious. Economic growth should continue to be modest. It appears most of the effects of the cliff have been avoided.

Ian Shepherdson, Pantheon Macroeconomics
When all the negotiations are over and a final deal is done, presumably by mid-March, we expect the net incremental fiscal tightening this year to be about 1.5% of GDP. That’s still far too much for such a fragile economy but it will not push the U.S. back into recession. The first half of the year will be difficult, but by the summer we think most of the fiscal hit will have been absorbed and better news on three fronts—bank lending, housing and the rebound in China—ought to become increasingly powerful forces boosting growth.

Maury Harris, UBS
Higher Federal income taxes on families earning over $450,000 per year in taxable income mainly will lower their personal saving rate as opposed to their consumption. (Higher relative saving rates for higher-income families are suggested by our following calculations based on 2011 BLS consumer expenditure survey data. We estimate that 94% of overall personal saving is done by the 18% of households with over $100,000 in annual after-tax incomes, and that 63% of personal savings is done by the 7% of households with over $150,000 in annual after-tax income.) Also, a rise in the top marginal income tax rate from 35% to 39.6% probably is not enough to much blunt the incentive to expand by the relatively more successful small firms paying the individual income tax.

Macroeconomic Advisers
While it may be a relief to have avoided plunging off the fiscal cliff, it is disconcerting how little progress has been achieved towards longer-term deficit reduction since the passage of the Budget Control Act of 2011. Estimates are that, relative to 2012 policy, ATRA 2012 will reduce deficits by only about $650 billion through 2022, with essentially none of that on the spending side of the ledger. There is a lot more work to be done!