As expected, Congress and the President reached a deal avoiding the worst of the fiscal cliff. I won't get into the politics of the deal, but it's surprising that there were virtually no net reductions in spending as part of the deal ($15 billion over 10 years). The response of both sides is that spending reductions will take place later, when there's no rush to meet a deadline. Perhaps. We'll find out soon as the next debate over the budget will take place in February as the US must raise the debt ceiling.
How does this affect the national debt over time? It has some impact, but clearly falls considerably short of what's necessary and doesn't address the primary issue - increases in entitlement spending, particularly Medicare and Medicaid. Any serious attempt to address future deficits and the national debt must reduce the growth of entitlements. For more details, see my my earlier post on the fiscal cliff.
Back to the economics. The good news is that the US didn't go off the fiscal cliff. Also, the tax increases shouldn't cause much harm to the economy over time. The tax on dividends and capital gains for upper-income earners rises to 20% from 15% and income tax rates rose modestly for the highest income earners. One can argue that this is not the best policy, but it's hard to argue that this will result in significant harm to long-term economic growth. In the near term, the increase in the payroll tax will be a drag on economic growth. All working Americans will experienced a 2% cut in after-tax pay (for wages and salaries up to just over $110,000). Clearly this will lead to some combination of less consumer spending and less personal savings. On the flip sides, the fiscal cliff deal removes a lot of uncertainty about the tax code, which may help free up some spending. Overall, the deal will be a drag on economic growth for the first half of 2013. Given the economic weakness of the economy at the end of 2012 (weaker than expected Christmas sales along with an undesired buildup in inventories), economic growth should be quite weak as we begin the new year.
For more specifics, please check out my other website for various economic forecasts.
