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The Real Threat To The Economy Next Year Isn't The Fiscal Cliff

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Exactly what steps Congress takes in its lame duck session remain to be seen and will depend heavily on the outcome of the election. But some are likelier than others.

Most notably, leaders of both parties have been largely silent about the looming expiration of the payroll tax holiday. That would amount to a significant tax increase for millions of middle-income earners on its own, but would reduce next year's deficit by $100 billion or more.

Likewise, the Senate is weighing the possibility of delaying the sequester's automatic spending cuts by one year, and offsetting the $55 billion cost of doing so with different, more targeted cuts. Those cuts would likely be spread out over several years, but the more front loaded they are, they greater their economic impact will be in the near term.

Lastly, if Obama wins, Democrats will try to force House Republicans to end the Bush tax cuts for high income earners, bringing tens of billions of dollars out of the economy and into the Treasury.

If all of these things happen at once, economists say, it would slow if not stall the reduction in unemployment.

"If you get all three and no offsetting stimulative measures you knock around 1.2 [percentage points] from growth and add perhaps 0.6 [percentage points] to the unemployment rate," says Dean Baker, cofounder of the Center for Economic and Policy Research. "In a baseline, with no bad news from the government we might have expected to see 3.0 percent growth next year (housing comeback is the good news here) and perhaps a 0.4 [percentage points] drop in the unemployment rate. These three together get us down around 2.0 percent growth and basically no progress on unemployment."

That's based on what economists call Okun's law -- a rule of thumb that allows them to estimate how changes in GDP will impact employment. The estimates don't take into account that certain budget cuts hit the economy harder than others.

"It would be a real mistake to let the payroll cut expire next year -- bad at the micro level, as working families still face a tough job market, and bad at the macro level because it's got a strong multiplier and we need the spending," says Jared Bernstein, a one-time economic adviser to Vice President Joe Biden, currently on leave of absence from the liberal-leaning Center on Budget and Policy Priorities.

He says the payroll tax cut is the most important and frightening part of the coming austerity, both because it's a lot of money and because most of it goes to people with a high propensity to spend it.

"Conversely, high end [tax cut] expiration wouldn't be noticed much at all -- those folks aren't income constrained compared to middle class so unlikely you'd see their tax bump show up much in consumer spending," he says.

The threat of sudden austerity, particularly the lapsing payroll tax cut, is starting to worry at least one senior lawmaker.

"We should not even be considering extending tax breaks for high-income individuals, which do virtually nothing to help the economy but increase the deficit -- we shouldn't be talking about that when obviously there is a better alternative on the table," Rep. Chris Van Hollen (D-MD), the top Democrat on the House Budget Committee told the Washington Post.

"We've gone through an extraordinarily difficult economic period. Everyone would agree the economy remains fragile. This should be considered for another year. Its multiplier effect on jobs and the economy is much more powerful than other ideas that have been put on the table. It's certainly more powerful than providing a tax break for very wealthy people, who are essentially sitting on their funds."

About The Author

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Brian Beutler is TPM's senior congressional reporter. Since 2009, he's led coverage of health care reform, Wall Street reform, taxes, the GOP budget, the government shutdown fight and the debt limit fight. He can be reached at brian@talkingpointsmemo.com