There will not be much to celebrate come January 1 if Congress is unwilling to come to an agreement on taxes and spending. Assuming gridlock persists, we can expect high tax increases and automatic spending cuts that would likely plunge us back into a recession. We ride on the edge of the “fiscal cliff” due largely to a lack of action taken by Congress back in 2011, when leaders neglected to come to an agreement on how to deal with the enormous federal deficit spending that endangered the security of the economy. AEI tax expert Aparna Mathur elaborates:
As Mathur highlights, the pending recession comes out of a decision from Congress in 2011 to implement automatic tax rate increases and spending cuts for January 2013 in order to afford the increase in the debt ceiling. The trouble is, the economy did not recover as projected, making it probable that the increases and cuts will choke an already-struggling recovery.
It is obvious Congress must take action. What are the biggest challenges preventing an agreement?
It comes down to how the two parties approach the problem of lowering the deficit. Democrats historically want to raise revenues by raising taxes on the rich while simultaneously increasing funds for entitlement programs, while Republicans wish to raise revenue by lowering spending and promoting small business and job creation. The only solution: Compromise.
What are the ramifications if Congress ultimately does not come to an agreement? Senior AEI economist Alan Viard reports that people’s paychecks will shrink in January from the tax increases and military contractors will see smaller returns due to defense cuts.
AEI’s Vice President of National Research Initiative Henry Olsen predicts that we can expect to see a short-term rise in unemployment as some companies go out of business, while the military cuts would result in a reduction of our influence oversees.
To be clear, neither party suggests raising taxes on the middle class.
Both sides agree that the 98% of Americans making less than $250,000 a year should avoid a tax hike when the tax cuts from the Bush administration expire on December 31, Obama and Democrats argue. They call for the House to guarantee that outcome by passing the Senate measure now.
What needs to happen is for Democrats to rein in the spending on entitlements by passing reforms of Medicare and Medicaid, in exchange for an agreement from Republicans to increase revenue by taxing top earners. Taxing the top, as John Boehner suggested Monday, does not have to come from increasing the tax rates. Closing the loopholes and eliminating tax breaks would have the same effect of increasing revenue, thus laying down a solution on the table that saves face for Congress and sidesteps the looming recession that no one wants.