US economy could handle short fall over 'cliff'

Published on NewsOK Modified: December 26, 2012 at 11:42 am •  Published: December 26, 2012
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— The stock market would probably drop, though maybe not by much. Many Wall Street analysts expect a partial deal of some kind. "There is starting to become a little bit of an acceptance that we fall off the fiscal cliff," said J.J. Kinahan, a strategist for TD Ameritrade.

— 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.

If no deal at all was reached by January and budget talks dragged on, many businesses might put off investment or hiring. That's why most economists say it would be crucial to reach a deal within roughly the first two months of 2013.

In addition, many more people would be affected if something called the alternative minimum tax isn't fixed.

The financially painful AMT was designed to prevent rich people from exploiting loopholes and deductions to avoid any income tax. But the AMT wasn't indexed for inflation, so it has increasingly threatened middle-income taxpayers. Congress has acted each year for a decade to prevent the AMT from hitting many more people.

If it isn't fixed again, roughly 33 million taxpayers, including married couples with income as low as $45,000 — down from $74,450 in 2011— could face the AMT. Previously, only 5 million taxpayers had to pay it. Taxpayers subject to the AMT must calculate their tax under both the regular system and the AMT and pay the larger amount. Without a fix, a middle-income household would pay an average of $1,231 more, according to the Tax Policy Center.

The IRS has said it assumes Congress and the White House will fix the AMT in a deal to avoid the cliff. If they don't, the IRS will need weeks to reprogram computers and make other adjustments. In the meantime, about 100 million taxpayers couldn't file tax returns early next year because they couldn't determine whether they owe the AMT. Refunds would be delayed.

The gravest scenario would be if the budget talks collapsed and the tax increases and spending cuts appeared to be permanent.

In that case, Macroeconomic Advisors warns that the Dow could plunge up to 2,000 points within days. Businesses would turn gloomier in anticipation of Americans paying higher taxes and spending less.

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. But with the two sides deadlocked, Boehner scheduled a vote on a bill to prevent taxes from rising on those earning less than $1 million a year. Opposition from anti-tax conservatives, and Democrats, forced him to cancel the vote.

The gridlock caused stocks to fall Friday. The Dow Jones industrial average dropped 121 points.

Obama called for a vote on a stripped-down agreement that would raise taxes only on the wealthiest 2 percent of Americans and extend emergency unemployment benefits. Automatic spending cuts would be postponed.

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.

And if the crisis is resolved, as many expect, the boost to business and consumer confidence would encourage more hiring and spending.

"We could end up with a much more robust recovery than anybody's envisioned" if a deal is reached, said David Cote, CEO of Honeywell International.

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AP Business Writers Christina Rexrode, Steve Rothwell and Daniel Wagner contributed to this report. Rexrode and Rothwell reported from New York.

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