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Not All Parts of Fiscal Cliff Are Created Equal

In this month’s edition of Jobs Count, I looked at the Congressional Budget Office’s report on the employment and GDP effects of the fiscal cliff. The CBO report spells out how many jobs lost and how much GDP would be reduced for each deficit reducing policy that is a part of the fiscal cliff. Overall, if the fiscal cliff is not averted, and its major deficit reduction policies take place, the nation could lose 3.4 million jobs and GDP could decline  by 2.9 percent.

With the economy still fragile, it would be ideal to defer any deficit reduction until later, which would allow for more deficit reduction at a smaller cost to the economy. But, while ideal, it is also not likely, so some deal on the fiscal cliff will probably be made, with some aspects of deficit reduction policies kept, despite the potential negative economic impact. 

If a deal is made that keeps some aspect of the fiscal cliff, policymakers ought to look at how they can get the most deficit reduction for the least harm to the economy. As the analysis in this months Jobs Count showed, some parts of the fiscal cliff have a greater impact on the economy than others. However, the size of their impact on the economy does not perfectly correspond to the amount of deficit reduction they achieve, as this chart shows.

Source: Congressional Budget Office

For example, look at the payroll tax cut/unemployment insurance extension. Its impact on the deficit is roughly equivalent to its impact on the economy. Allowing its expiration to take effect accounts for roughly 22% of the fiscal cliff’s total deficit reduction, 24% of its impact on GDP, and 24 percent of the job loss.

Compare that to the defense and nondefense spending cuts. Together they account for about 13% of the fiscal cliff’s deficit reduction, but they account for nearly twice as much of the economic impact: 27% of the GDP decline, and 24% of the job loss.

In the other direction is the expiration of the Bush tax cuts on high income earners. The expiration accounts for over 8% of the total deficit reduction, but only 3 percent of the GDP decline and less than 6% of the job loss.

As policymakers debate how to address the fiscal cliff, they should keep in mind that some aspects of the fiscal cliff matter much more to the budget than they do to the economy.

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