Which Areas of the Fiscal Cliff Will Have the Worst Impact?

The fiscal cliff encompasses many revenue and expenditure details, details which provide full employment for government bureaucrats concerned about accounting for all the nuances of federal government expenditures.

The details of the fiscal cliff discussion between Republicans and Democrats, though, can easily be classified into 13 broad categories, shown in the follow table.

Which of these areas is likely to have the largest short term and long term detrimental impact on business and economic health of businesses located within the United States?

Well, to answer this one would need to estimate the dynamic impacts from the static effects estimated by economist working for such agencies as the Congressional Budget Office or the President’s Office of Management and Budget.  When doing this, the overall revenue and expenditure impact comes out to about $605 billion, with the largest anticipated effect coming from a potential tax burden increase should the Bush tax cuts expire ($221 billion).

The static effects, of course, don’t measure what will happen as the direct effects are felt throughout the economy.

So, which of the 13 possibilities are likely to have the largest detrimental impact when considering the indirect multiplier effects?  Well, let’s start from the bottom.

13.  Physician reimbursements: the total cost savings to the federal government’s balance sheet amounts to about $11 billion.  The medical industry generally has higher multipliers (although not nearly as high as the automobile industry), but the industry is able to withstand $11 billion in federal government savings.  The expenditure reductions are likely to have little impact on economic growth overall or in the medical industry.  Interestingly, most observers think the medical lobby will get the savings reversed – a sign of the medical industry’s muscle.

12.  The second least likely area to cause significant damage are the taxes contained in the Affordable Care Act (“Obamacare”).  Although the new taxes will further deteriorate America’s competitive position, it’s not the taxes that causes the largest detrimental effect, it’s the regulations.

11.  The third least likely to cause adverse side effects is the potential lack of action to extend the unemployment benefits.  Individuals receiving unemployment benefits certainly spend a large portion of their income, but it’s generally on lower end retailing, something that’s unlikely to cause significant damage.

10.  Coming in at number 10 are the “dreaded” budget cuts from sequester.  It’s certainly the case that many individuals and companies with high multiplying effects are connected to the sequester issue, but the worker and firm displacement will probably be replaced by small business startups and other productivity enhancing activities.

9 & 8.  The estate tax increases come in at numbers eight and nine.  The estate tax largely causes deadweight loss in wealth accumulation.  Without going into further detail, the deadweight loss and the shifting high income individuals make to avoid the death tax largely represent only income for lawyers and accountants and a bunch of wasted time and energy on the part of the wealth creators and their families.

7.  Although representing $95 billion in value, the payroll tax cut comes in at number 7 because the multiplying effect has already been baked into households’ balance sheets.  The increase will certainly be noticed by retailers, but is likely to come at the expense of savings instead of spending.

6.  The potential for the President and Congress to fail to act on an AMT fix represents some large potential shifting in economic activity if nothing is done.  Middle to higher income individuals are more likely to adjust their investment, saving, and spending behavior to account for the tax increase.  The AMT fix applies to a different group of people than does the payroll tax cut.

5.  The potential large tax increase for lower and middle income households represents a large economic risk.  Because the higher tax rates could potentially affect most taxpayers, the tax burden increase would likely come at the expense of investment and spending decisions of more taxpayers than the AMT.

4 &3.  Increasing the top dividend and capital gains tax rates by such large amounts would in all likelihood cause a large shift in business and individual investment activity.  In the long run, the ongoing taxes the federal government gets by taxing capital gains would likely decelerate as well.  This one is a lose-lose.

2.  Coming in as the runner up are the tax extenders.  Many industries depend on the tax expenditures contained in this package, and eliminating such tax breaks would certain cause some companies to either shift production overseas, reduce employment, or file for bankruptcy.

1.  Coming in at number 1 are the Bush tax cuts.  With $221 billion initially at stake, and at least a trillion at stake when the multiplying effects are accounted for, this will likely cause the largest amount of long term damage to businesses competing in a global environment.  It really does represent a cost to doing business.

Overall, the effects of the different aspects of the fiscal cliff matter, and not just in a political sense.