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U. S. economy could handle short fall over 'fiscal cliff'

Even if New Year's passed with no deal, businesses and consumers would not likely panic as long as some agreement seemed imminent. The $671 billion in tax increases and spending cuts could be retroactively repealed.
By CHRISTOPHER S. RUGABER Modified: December 26, 2012 at 9:50 pm •  Published: December 27, 2012
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The economic threat that's kept many Americans on edge for months is nearing reality — unless the White House and Republicans cut a budget deal by New Year's Day.

Huge tax increases. Deep cuts in domestic and defense programs. The likelihood of sinking stock prices, reduced consumer spending and corporate layoffs. The risk of a recession within months.

Still, 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. President Barack Obama and members of Congress will return to Washington on Thursday.

Retroactive repeal

Even if New Year's passed with no deal, businesses and consumers would not likely panic as long as some agreement seemed imminent. The $671 billion in tax increases and spending cuts could be retroactively repealed.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.”

It's always possible negotiations between President Barack Obama and Republican congressional leaders will collapse in acrimony. The prospect of permanent tax increases and spending cuts could cause consumers and businesses to delay spending, hiring or expanding.

Without any agreement at all for months, the “fiscal cliff” would cause the U.S. economy to shrink 0.5 percent in the first half of 2013 and fall into recession, the Congressional Budget Office estimates.

Economists optimistic

But most economists expect a deal, if not by New Year's then soon after. Businesses and consumers will likely remain calm as long as negotiators seem to be moving toward an agreement.

“The atmosphere is more important than whether the talks spill” into next year, said Paul Ashworth, an economist at Capital Economics.

Here's why many are optimistic that a brief fall over the cliff wouldn't derail the economic recovery:

Though the “fiscal cliff” would boost taxes by $586 billion for all of 2013, the tax hit for most people would be modest 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. That would be a significant bite over the full year, but the initial hit would be just $130 in January, according to the nonpartisan Tax Policy Center.

About a third 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.

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