Faculty view fiscal cliff with apprehension

With the end of 2012 rapidly approaching, efforts to avert the fiscal cliff — a combination of automatic spending cuts and tax hikes set to kick in at year’s end — have dominated the national political dialogue in recent weeks. In light of the negotiations currently ongoing within Congress, The Daily spoke with Hoover Institution fellow John Cogan on the issues at stake, the negotiations’ likely outcomes and the potential significance of the fiscal cliff to the broader economy.

The Stanford Daily (TSD): Where does Congress currently stand in the fiscal cliff negotiations? What are the critical issues under discussion?

John Cogan (JC): As we sit here on Dec. 20, both sides are still in “posturing mode.”  This should not be surprising. Most negotiations to resolve important issues, both in the public and private sector, tend to go down to the wire.

The critical immediate issue involves taxes. The longer-run issue involves curtailing the growth in federal spending.

The failure to reach an agreement will cause an across-the-board hike in taxes. Income taxes will rise by more than one-third. Every taxpaying household will face an increase, but middle income households will be especially hard hit. The tax reductions enacted more than a decade ago disproportionately benefited the middle class. Their expiration will disproportionately harm them. The spending reductions that would be caused by the sequester are, in contrast, quite modest.

TSD: How far from an agreement is Congress? Can we expect resolution before the end of 2012?

JC: They seem pretty far apart.  We should all hope for a resolution.

TSD: How economically damaging would a failure to reach a settlement on the fiscal cliff be?

JC: The failure to reach an agreement would be harmful.  But its unclear just how much harm would be done.  Frankly, we are in uncharted territory.  This country has never experienced an increase in taxation of the magnitude that going over the fiscal cliff would produce.

TSD: What kind of shape would any settlement likely take? Is a long-term solution possible?

JC: My crystal ball is no clearer than yours. But I do not believe a long-term solution is likely.  The most likely outcome is an agreement that will kick the fiscal can down the road.

TSD: Do any of the proposals put forward to date effectively address the issue of the federal budget deficit?

JC: No. The solution to our deficit and debt problem is to restrain the increase in government spending, mainly entitlement spending, and enact policies that will allow the private economy to grow more rapidly on a sustained basis. Sustained economic growth is essential to providing the resources needed to finance the rising entitlement burden.

History has shown the restraining the growth in spending requires presidential leadership. To date the president has shown none.  He has offered no significant proposals to address entitlement spending. His proposal to raise tax rates is estimated to reduce the deficit in the short-run by less than 10 percent.  In the long run, higher tax rates will distort resource allocation and, as a result, reduce the annual budget deficit by less than that amount.

House Republican leaders have shown a willingness to compromise on taxes, reversing a two-decade long opposition to any increase in taxes. But they have been offered few specific reforms in entitlements of their own.

TSD: Did the 2012 elections have any impact on the process of negotiating a solution to the fiscal cliff?

JC: It may seem that the re-election of the president and a Republican controlled House of Representatives has made the process of reaching a solution difficult. But we must keep in mind that the source of our budget problem, entitlement spending, has been the result of actions by both political parties. Any solution to the fiscal problem will likely require bipartisanship.

About Marshall Watkins

Marshall Watkins is the executive editor of The Stanford Daily, having previously worked as an opinions columnist, the summer managing editor, the managing editor of news, a news desk editor and a news and sports writer. He is a junior from London majoring in economics, and can be reached at mtwatkins@stanford.edu.