Economic Research
April 26, 2012
Special Report
Contents:
US: fiscal cliff notes
I: Head-first into the fiscal meat grinder
What about the debt ceiling?
How big are the Bush tax cuts?
II: The 2012 political season
BCA—pain all around
Payroll tax and unemployment benefits
III: Looking beyond the cliff
Fading of stimulus
A farewell to arms
And in summation...
• Current law has a massive fiscal tightening—around a half trillion dollars—set for the beginning of next year
• Our baseline view is that the vast bulk of this fiscal tightening will be
deferred to later years
• Even so, the uncertainty over the fiscal outlook is likely to loom over the
economy until after the November election
• Even with an extension of most of the expiring year-end measures,
federal fiscal policy will weigh on growth
• This fiscal drag, around a 1.4%-pt drag on GDP growth next year, is
likely to occur regardless of the November election outcomes
The political path between now and the November elections is relatively clear:
only minor new legislation is expected to come out of Washington, Mitt Romney
will challenge the Democratic incumbent Barack Obama for the White House,
the Republicans will look to defend their hold on the House of Representatives
and will attempt to wrest control of the Senate from the Democrats. The stakes of
the election outcome—always enormous—will in this cycle also be immediate.
At the end of the year, only seven weeks after the election, the nation will arrive
at a fiscal cliff: the scheduled sunsetting of the Bush tax cuts, worth hundreds of
billions of dollars per year, the expiration of the 2%-point payroll tax holiday and
emergency unemployment compensation, and the automatic budget cuts written
into the Budget Control Act as penance for the Supercommittee’s failure to reach
agreement last fall. All told, under current law, through a combination of tax
hikes and spending cuts, fiscal policy is set to tighten by over $500 billion at the
beginning of next year. Not only is that an enormous sum—almost 4% of GDP—
but it is all set to occur at a single point in time.
Were current law to remain unchanged, this would lead to an almost certain
recession. The implied fiscal drag, set against a recovery that has struggled to
average 2.5% GDP growth, would probably be too much for the economy to
shoulder. However, laws can be changed. And it is our best guess that these
laws will be changed, and that most of the tightening of fiscal policy will be
temporarily or indefinitely deferred to future years. If current polling holds up,
The January fiscal cliff
Michael Feroli
Calendar year 2013
Sunsetting of Bush tax cuts
Expiration of payroll tax holiday
Expiration of emergency unemployment benefits
Budget Control Act spending cuts
Total
$ bn
$280
$125
$40
$98
$543
% of GDP
1.8%
0.8%
0.3%
0.6%
3.5%
(1-212) 834-5523
michael.e.feroli@jpmorgan.com
Deficit decomposition under J.P. Morgan policy assumptions
FY, % of GDP
Deficit
Automatic stabilizers
TARP
Structural deficit
Fiscal thrust or drag
Memo: fiscal thrust assuming all of fiscal cliff is realized
2009
-10.2
-2.1
-1.1
-7.0
4.1
4.1
2010
-8.9
-2.3
0.8
-7.4
0.4
0.4
Note: fiscal thrust is the negative of the change in the structural deficit, adjusted to remove TARP.
2011
-8.6
-1.9
0.2
-7.0
-0.4
-0.4
2012f
-7.7
-1.7
-0.1
-5.8
-1.2
-1.2
2013f
-6.1
-1.7
0.0
-4.5
-1.4
-3.3
www.morganmarkets.com
2
2
3
5
6
6
7
7
8
8
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
divided government is likely to persist after the election.
While each side sees elements of current fiscal policy that
it would like to change, neither side has an incentive to
throw the economy into recession. The game of chicken
may prevail into late December, but we believe that—as
was the case in late 2010 when faced with a similar situation—the path of least resistance will be to extend current
policy for another year or two. Even with this relatively
benign outcome, the uncertainty regarding numerous aspects of tax policy will likely affect decision-making, cause
business and household choices to be delayed, and retard
the pace of economic activity closer to year-end.
There are risks. The first risk is that one party or another
gambles on taking a hard line. A second, smaller risk is that
one party gains control of both the White House and Congress. This will likely imply more near-term tightening of
fiscal policy, as each party has oxen they would be happy
to have gored.
Even with a year-end agreement to extend expiring fiscal
measures, fiscal policy will continue to weigh on growth
next year for two reasons:
Economic Research
US: fiscal cliff notes
April 26, 2012
What about the debt ceiling?
One issue that is sometimes included in the host of year-end
fiscal questions confronting the economy is the prospect of
the Treasury again running into the debt ceiling. Recently
the room under the debt ceiling has been about $780 billion.
By our estimate of the deficit, this implies that the debt ceiling will be hit in December, around the same time all of the
other fiscal issues come to a head. Recall, however, that
Treasury can and has used various accounting gimmicks to
extend the “drop dead” date on the debt ceiling. Last year,
these gimmicks bought the Treasury about two-and-a-half
months of extra time. Assuming a similar capacity to use
these gimmicks, this would imply the “drop dead” date on
the debt ceiling isn’t until February, after Inauguration Day
2013. If there is a “grand bargain” in the lame duck period
between Election Day and Inauguration Day, it will likely
include an extension of the debt ceiling. However, such an
extension does not have to happen until well past the other
fiscal cliff issues.
Debt ceiling headroom: debt ceiling less debt subject to limit
$ bn
• Stimulus spending, both from the 2009 Recovery Act
and from subsequent extensions, continues to decline,
2500
• Military spending is set to decrease, particularly as operations in Iraq and Afghanistan wind down.
1500
In sum, we do not see the doomsday scenario playing out:
policymakers are unlikely to drive the US economy off the
fiscal cliff. Nonetheless, fiscal policy will continue to be a
drag on the economy next year.
The next section describes the fiscal issues that must be
confronted at year-end. The following section discusses
various political outcomes and how they will affect the
choices made with respect to the year-end issues. The final
section discusses fiscal issues other than the year-end ones.
I: Head-first into the fiscal meat grinder
The fiscal issues facing the economy early next year can be
divided into four subcategories: expiring Bush tax cuts,
expiring payroll tax and unemployment benefits, automatic
budget cuts associated with the Budget Control Act, and
the “usual” expiring provisions: AMT, “doc fix,” business
tax extenders, etc. We discuss each in turn below.
Bush tax cuts: The “sunsetting” of the Bush tax cuts is set
to raise income tax rates across all income levels in 2013.
For 2012, marginal tax rates ranged from 10% to 35%. If
2
2000
1000
500
0
05
06
07
08
09
10
11
12
13
Income tax rates for 2012
Single
Up to $8,700
$8,701 to $35,350
$35,351 to $85,650
$85,651 to $178,650
$178,651 to $388,350
Over $388,351
Taxable income
Married, filing jointly
Up to $17,400
$17,401 to $70,700
$70,701 to $142,700
$142,701 to $217,450
$217,451 to $388,350
Over $388,351
Marginal tax rate
10%
15%
25%
28%
33%
35%
Income tax rates for 2013, current law
Single
Up to $35,350
$35,351 to $85,650
$85,651 to $178,650
$178,651 to $388,350
Over $388,351
Taxable income
Married, filing jointly
Up to $70,700
$70,701 to $142,700
$142,701 to $217,450
$217,451 to $388,350
Over $388,351
Marginal tax rate
15%
28%
31%
36%
39.6%
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
Economic Research
US: fiscal cliff notes
April 26, 2012
sunsetting occurs as currently scheduled, marginal tax rates
will range from 15% to 39.6% in 2013 (tax rates by income
bracket are detailed in tables on the right).
How big are the Bush tax cuts?
Along with the changes in income tax rates, there are several other changes associated with the Bush tax cuts that
are currently set to occur in 2013. The Federal Child Tax
Credit will revert from $1,000 to $500 per child for eligible
families. The maximum tax rate for long-term capital gains
will be raised from 15% to 20%, and there will no longer
be a distinction between ordinary and qualified dividends
(effectively raising the tax rate on dividend income to the
ordinary income tax rate). There are a few tax provisions
related to married couples filing jointly that will also expire. And the phasing out of personal exemptions and itemized deductions that were eliminated by the Bush tax cuts
will resume in 2013.
The size of these tax cuts is discussed in the box to the
right. For calendar year 2013, the hit to disposable income
on an accrual basis from the sunsetting of the Bush tax cuts
could be around $280 billion, which is almost 2% of GDP.
If such an increase in taxes were anticipated to be permanent (which seems more likely than in the case of the “temporary” payroll tax holiday), then the impact on spending
would be larger. Even assuming a multiplier of two thirds,
which is at the lower end of the range of estimates, the hit
to consumer spending would be around $190 billion, or
about 1.25% of GDP.
Payroll tax and unemployment benefits: We lump these
two different issues together because historically they have
been legislatively linked. The 2%-point reduction in employee payroll taxes was initially a one-year tax holiday that
took effect at the beginning of 2011. At the end of last year
the tax holiday was extended another year, and now is once
again set to expire on New Year’s Day. The payroll tax holiday gives the average American about $1,000 per year in
extra spendable income. At an aggregate level it amounts to
about a $125 billion annual lift to disposable incomes. While
some of this extra income may be saved or used to pay down
debts, our estimate—based on prior academic studies—is
that about two thirds goes to increased spending. Thus, the
payroll tax holiday may be supporting consumer spending by
about $80 billion, or around 0.5% of GDP.
Emergency unemployment compensation (EUC) was first
passed into law in 2008 and was designed as a supplement
to the regular 26 weeks of benefits available in most state
unemployment insurance schemes. EUC has been expanded and extended numerous times in the four years
since it was created, most recently it was reauthorized
A variety of numbers have been circulated as to the size of
the Bush tax cuts. Most estimates key off of the calculations performed by the CBO—the well-respected nonpartisan arbiter of fiscal issues. However, some care needs to be
used in interpreting its various estimates. For example, the
CBO estimates that the sunsetting of the Bush tax provision
would only widen the deficit by $107 billion in fiscal year
2013. However, translating this into an economically useful
number requires at least three considerations.
First, the $107 billion figure does not account for the interaction of the Bush tax cut with the AMT patch. Should the
AMT be patched—which we think is the overwhelmingly
most likely outcome—then the amount by which individuals get “whacked” by the expiration of the Bush tax cut increases a lot. By the CBO’s estimate if the AMT were
patched, the expiration of the Bush tax cuts would cost US
households $143 billion in fiscal year 2013, on a cash basis.
Second, the figures above are fiscal year measures, meaning the first three quarters of calendar year 2013. Since individuals pay income tax on a calendar year basis, the
above numbers need to be scaled up by 4/3 to arrive at a
calendar year equivalent: this translates the above figure to
$191 billion for calendar year 2013.
Third, these numbers are on a cash accounting basis. However, the sunsetting of the Bush tax cuts means individuals
would accrue taxes at a higher rate during 2013, even if
those taxes aren’t paid out on a cash basis until the April
2014 tax season. An example here is estate and gift taxes,
almost all of which, should the Bush tax cuts expire, would
be paid in early 2014 rather than during 2013. The economically relevant concept—both behaviorally and in the NIPA
data—is the accrual rather than cash concept. Once one includes accruals that would be paid out in early 2014, the hit
to household disposable income in 2013 from the expiration
of the Bush tax cuts is probably around $280 billion.
The size of the Bush tax cuts in 2013
$ bn
Fiscal year, cash basis
Fiscal year, cash basis, with AMT patch
Calendar year, cash basis, with AMT patch
Calendar year, accrual basis, with AMT patch
$107
$143
$191
$280
Source: CBO
3
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
through the end of this year. Currently there are about three
million beneficiaries receiving EUC payments, which have
recently been paid out at an annual rate of around $45 billion. Unemployment benefits are probably even less likely
to be saved or used to pay down debt than temporary tax
cuts, and so by our estimate may be lifting consumer
spending by around $40 billion, or just under 0.5% of
GDP. EUC and a companion program, extended benefits
(EB), are funded through year-end, though the latest authorization has begun to reduce the generosity of the benefits.
Budget Control Act: The debt ceiling fiasco in the summer of 2011 was resolved with the Budget Control Act
(BCA), which tasked the so-called Supercommittee with
finding $1.2 trillion of deficit reductions over the ensuing
10 years. When the Supercommittee failed to come to an
agreement, the BCA stipulated automatic federal spending
cuts (or sequestrations) of $100 billion per year beginning
in early 2013. Before we discuss how we think this plays
out (in the next section), we first list the possible options
for the BCA outcomes:
• Current law is overturned. With simple majorities in both
chambers of Congress, the sequestration procedure can
be overturned, and there would be no cuts in 2013. Since
this would likely face a filibuster in the Senate, realistically it would require 60 votes in that chamber to pass.
This is the outcome that would likely produce a US debt
downgrade; whether that has any real impact on the
economy is debatable. A related outcome is that current
law is completely replaced; presumably for this to avoid
a downgrade the replacement would have to be equally
austere.
• Current law is allowed to run its course, and sequestration is activated in early 2013. The sequestration would
reduce spending in that year by about $98 billion, with
defense taking half the hit, and domestic discretionary
spending and Medicare taking the other half. This outcome could reduce GDP by about 0.6% next year.
• Between now and the beginning of 2013 Congress finds
some of the $1.2 trillion in deficit reductions in the 10year horizon, thereby eliminating or at least blunting
some of the impact of the 2013 sequestration. Note that if
Congress gets “partial credit,” i.e., finds some, but less
than $1.2 trillion, in deficit reductions, then there are two
paths that can be taken. The deficit reductions could reduce the sequestration in 2013, or, the deficit reductions
could push back the sequestration to the following year
(provided the partial credit earned is for at least $98 billion in deficit reductions).
4
Economic Research
US: fiscal cliff notes
April 26, 2012
Maximum duration for unemployment insurance benefits
Weeks
Regular benefits
EUC (all tiers)
Extended Benefits
Total
Through May
26
53
20
99
Through August
26
53
Through December
26
47
79
73
This table represents the maximum possible duration across all states anticipated by Congress
during the passage of The Middle Class Tax Relief and Job Creation Act of 2012. Individual
states have different rules regarding unemployment insurance and certain programs can be
triggered on or off in states depending on specific economic conditions.
Persons receiving Extended Benefits and EUC benefits
000s, nsa, both scales
1000
6000
800
5000
600
4000
Extended Benefits
3000
400
2000
200
0
2008
1000
EUC
0
2009
2010
Usual expiring provisions: The three issues listed
above—Bush tax cuts, payroll tax and unemployment benefits, BCA—are all fairly unique to this year. In addition,
there are several fiscal policy issues coming up at year-end
that usually come up. First, the Alternative Minimum Tax
(AMT) must be “patched” in order to prevent 30 million
middle class taxpayers from getting hit with the higher
AMT rate. Second, Medicare reimbursements need to be
adjusted with another short-term “doc fix.” Third, expiring
business tax credit such as the R&D tax credit need to be
extended; many of these have already lapsed so they will
also need to be extended retroactively. All three of these
measures are popular, enjoy bipartisan support, and have
routinely been extended in recent years. We expect this time
around will be no different and do not consider these programs to be part of the unique “fiscal cliff” issues facing
lawmakers at the end of 2012. The remainder of this note
assumes these measures are extended.
Summing up GDP impact: If there were no changes to
current legislation, the fiscal cliff impact on GDP growth
next year (excluding the usual expiring provisions) adds up
to a 2.75%-point drag. Moreover, this is probably an understatement, given our use of fairly conservative multipliers.
Given the economy has averaged 2.5% growth so far in this
expansion, its not hard to see that this could be a major
problem. The next section discusses how the political class
may respond to this situation.
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
II: The 2012 political season
To have a view on the economy in late 2012 and on into
2013, one needs to have a view on how the impending fiscal issues are resolved, and to have a view on how the fiscal issues are resolved, one needs to have a view on the
outcome of the 2012 general elections. We are not political
experts. Moreover, as Daniel Kahneman persuasively demonstrates in his recent best-seller Thinking, fast and slow,
even political experts have very limited success in predicting political outcomes. With that in mind, we look at different scenarios for the outcome of the November elections,
first focusing on the fate of the Bush tax cuts. In all cases
the current White House and Congressional composition
will need to reach at least a temporary agreement to get
past the New Year.
Obama reelected, GOP holds House, gains majority
(though not super-majority) in Senate. According to the
betting, or prediction, markets (e.g., Intrade, Iowa Electronic Markets), this is the most likely outcome. In this
case, all participants at the bargaining table agree that the
Bush tax cuts applicable to those making under $200,000
should be extended. The Republicans also want to extend
the upper brackets, thereby leaving the current tax code
intact, whereas Obama would seek to raise the upper brackets back to pre-2001 levels. In this case, the simplest solution is to extend the current tax code for another year or
two. Indeed, a very similar setup confronted legislators in
late 2010, when the Bush tax cuts were originally scheduled to sunset. The showdown was resolved by extending
the tax code for another two years. In that episode the concession the Republicans made for the extension of the upper brackets was the payroll tax holiday and extension of
unemployment benefits. It is likely that a similar concession would accompany an extension of the Bush tax cuts at
the end of this year.
One risk to this outcome is that Obama has stated that he
would never again extend the upper-income brackets. Of
course, bluffing is common practice in brinksmanship, but
the key question is which party can outmaneuver the other
in assigning blame for a failure to extend the Bush tax cuts.
Realistically the party that is most stubborn in the negotiations will likely get saddled with the blame. For Obama to
hold out to “merely” get upper-income tax hikes—which
amount to about a quarter of the overall revenue produced
by sunsetting the Bush tax cuts—would likely prove to be a
risky strategy for the President. (Similarly, for the Republicans to hold the popular middle-class tax cuts hostage to
getting their way on other legislation would also be dangerous). In short, we don’t think either side of the table has
Economic Research
US: fiscal cliff notes
April 26, 2012
Intrade odds for Presidential election
%, daily closing price
80
Obama elected
60
40
Republican elected
20
0
Jan 11
Apr 11
Jul 11
Oct 11
Jan 12
Apr 12
Jul 12
Intrade odds for Congressional elections
%, daily closing price
100
90
80
Republicans
control Senate
70
60
Republicans control
House
50
40
Jan 11
Apr 11
Jul 11
Oct 11
Jan 12
Apr 12
Jul 12
Intrade ascribes a small probability to the possibility that neither the Republicans nor the
Democrats control the Chambers of Congress.
appropriate incentives to follow the “nuclear” strategy of
allowing all of the tax cuts to expire and sink the economy
back into recession.
Obama reelected, Democratic Congress. According to
polls, Democrats face an uphill battle in taking the House,
or even in defending the Senate. Were they to do so, however, it is clear that the upper brackets would revert to pre2001 levels. This would imply a reduction in household
income of around $60 billion (this figure would be added
to the already-scheduled $20 billion reduction in disposable
income due to the new Medicare tax set to begin next year
as part of the Affordable Care Act). Given the current Republican control of Congress, the increase in taxes may
need to take place retroactively, after Inauguration Day, as
also happened in 1994. Some of this drag could be offset
by higher social spending elsewhere.
Romney wins, Republican Congress. In this scenario, the
Bush tax cuts would certainly be extended, most likely retroactively after Obama leaves the White House in late
January. Romney has recently campaigned on reducing income tax rates even further, though this seems to be a relatively recent rhetorical addition aimed at GOP primary voters. In this scenario the payroll tax cut and extended unem5
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
Economic Research
US: fiscal cliff notes
April 26, 2012
ployment benefits would likely be gradually phased out,
implying a reduction in disposable income similar to the
previous outcome. As with the case above, the change in
tax legislation would probably take place after the inauguration, and the additional fiscal drag could be offset by a
more generous tax code.
Contributions for government social insurance, domestic
Romney wins, Democratic Congress. This would certainly be an odd turn of events. While there are differences
with the diametrically opposed case of Obama winning and
Republicans taking Congress, we suspect the outcome
might not be all that different—a failure to agree leads to a
continuation of the status quo, though this outcome probably raises the odds of upper-income rate hikes.
BCA—pain all around
The resolution of the BCA requirements will also of course
depend on the outcome of the November elections, though
how the issue is navigated will largely be a Congressional
matter, with only limited White House involvement. The
first possible outcome (of the three BCA scenarios listed
earlier) is that Congress simply overturns the BCA.
Policymakers understand that the rating agencies would
react negatively to the repeal of BCA unless it were replaced with a similar deficit reduction measure. Moreover,
there are probably enough deficit hawks in the Senate to
prevent this from happening without the need for a 60-vote
majority. For these reasons, we think it is unlikely that the
BCA will simply be overturned by Congress.
The second scenario is that BCA is left to run its course,
and funds are automatically sequestered from defense and
nondefense spending programs. Such an outcome would
reduce defense spending by about 10% and Medicare and
domestic discretionary spending by about 8%. The hit to
the Department of Defense, at a time when defense capabilities are already being stretched fairly thin, has led to
considerable concern on the part of Congressional Republicans. This GOP opposition to the defense sequestration is
the main reason that we do not foresee the full sequestration taking place, and their concerns will be complemented
by Democratic displeasure with the prospect for such large
reduction in domestic spending programs.
We believe the third scenario, Congress gets “partial
credit,” is the most likely outcome. There are a few measures that have received some bipartisan agreement in the
past that could reduce the sequestration amount while still
putting off most of the tightening until a later date. For example, using the chained-CPI for indexing Social Security
and other benefits would produce a $200 billion savings
6
$ bn, saar
1000
950
900
850
05
06
07
08
09
10
11
12
13
Income from government unemployment insurance benefits
$ bn, saar
200
150
100
50
0
05
06
07
08
09
10
11
12
13
over 10 years, with most of the spending reduction taking
place in the back half of the planning horizon. Some of the
pain of sequestration could also be averted by the use of
budget “gimmicks,” such as counting the savings from a
realistic drawdown of troops in Afghanistan. Deficit hawks
oppose such fiscal voodoo, but such tricks may be necessary to reduce the amount of actual sequestration that takes
place next January to a more tolerable size. Our baseline is
that total sequestration that takes place next year is in the
$20-$40 billion range.
Payroll tax and unemployment benefits
The payroll tax holiday faces opposition from fiscal hawks,
while emergency unemployment compensation has met
with resistance from some within the Republican party.
Even so, these programs were extended by the Republican
House late last year, even though the Democrats and the
Administration had no bargaining chips. Evidently fear of
being blamed for ending these relatively popular programs
led the Republican leadership to blink at the last moment.
The extension of these programs highlights the difficulty a
Republican Congress may face in going cold turkey on
these two programs. Of course, if Obama is reelected it
may be even more difficult, as extending these two measures—which generally benefit lower and middle income
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
households—may be the price a Democratic administration
extracts in order to go along with an extension of the Bush
upper-income tax rates. In fact, just such a compromise was
how the payroll tax holiday was originally agreed to in late
2010. Our own expectation is that most, but not all, of these
two programs will be extended. If they are extended, it
would likely be in the context of reduced generosity of unemployment benefits, or perhaps lowering the payroll tax
holiday to 1%-point instead of 2%-points. In sum, our
baseline expectation is only limited drag from the gradual
removal of fiscal lift provided by these measures. To be sure,
this is the area of the fiscal cliff where the risk is greatest that
we end up with more tightening than we foresee.
III: Looking beyond the cliff
Current discussion of fiscal policy understandably focuses
on the year-end fiscal cliff issues. However, in order to
construct a holistic view of the impact of fiscal policy on
the US economy, a few points should be made regarding
non-cliff fiscal issues. In particular, even with the relatively
benign scenario laid out above, there are two aspects where
fiscal policy will likely remain tight:
Economic Research
US: fiscal cliff notes
April 26, 2012
Fiscal stimulus
FY, $ bn
ARRA
Non-ARRA
Total stimulus funds
Change in stimulus funds
% of GDP
2009
177
0
177
177
1.3
2010
323
92
415
238
1.7
2011
171
266
437
22
0.1
2012
39
247
286
-151
-1.0
2013
44
152
196
-90
-0.6
ARRA: American Recovery and Reinvestment Act of 2009
Defense outlays
% of GDP
Forecast
5.0
OMB
4.5
4.0
3.5
CBO, assuming troops in Mideast
operations down to 45,000 by 2015
3.0
2.5
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Change in defense outlays
• The winding down of stimulus outlays related to the
2009 Recovery Act as well as the numerous subsequent
additional stimulus acts.
% of GDP
Forecast
1.0
0.5
• The anticipated decline in defense outlays, partly related
to the wrapping up of operations in Iraq and Afghanistan.
0.0
Fading of stimulus
-0.5
Stimulus occurs when policymakers actively make choices
to change policy in order to provide more fiscal support to
the economy. The most notable example in the current cycle
is the 2009 Recovery Act, or ARRA. Not all of ARRA
should be considered stimulus, however, as some components—such as patching the Alternative Minimum Tax to
prevent a large middle-class tax hike—occur every year. The
only reason the AMT is not permanently extended is so that
Congress can preserve an accounting mirage. For this reason, we exclude these “extenders” in the stimulus table on
this page. More important for understanding the outlook is to
remember that not all stimulus measures undertaken in the
current cycle were contained in ARRA. Perhaps the most
prominent such measure is the payroll tax holiday, which
was initially conceived to offset the tax hike that took place
when the Making Work Pay tax credit—which was part of
ARRA—expired at the end of 2010.
However, in the years since the recession there have been
numerous other smaller legislated changes to tax and
OMB
CBO, assuming troops in Mideast
operations down to 45,000 by 2015
-1.0
80
85
90
95
00
05
10
15
spending policy to support the economy, including extending unemployment benefits, COBRA health coverage benefits, state fiscal relief, etc. A recent tabulation by the Center for Budget and Policy Priorities places the bill for these
non-ARRA stimulus measure over the 2009-2013 period at
$640 billion, almost as much as the ARRA stimulus measures impact on deficits over the same period, which is
about $754 billion.
Even with the recent extension of the payroll tax holiday,
the amount of support provided to the economy through
discretionary fiscal actions is set to contract this year,
which will be a headwind to growth. The total amount of
stimulus-related outlays and tax expenditures will contract
by about 1% in fiscal year 2012. The exact multiplier effect
of this financial measure on GDP is uncertain, but using a
7
JPMorgan Chase Bank NA, New York
Michael Feroli (1-212) 834-5523
michael.e.feroli@jpmorgan.com
Economic Research
US: fiscal cliff notes
April 26, 2012
fairly standard multiplier of 1.0 would imply that the waning of stimulus could subtract about 1%-point from growth
this year. Changes in defense outlays have been dominated
by noneconomic considerations, and so they are not included in the above calculations, which measure the fiscal
policy response the Great Recession.
One potential offset is that some of these expenditures go
to foreign nationals for services provided in the theater of
operations. In the economic accounts, these purchases are
considered imports. Such “imported” defense expenditures
are less than $30 billion, whereas the decline in defense
spending over the next few years will likely amount to over
$100 billion. So even if defense imports fell to zero, this
offers only a partial offset to the domestic drag that is set to
occur from reductions in defense outlays.
A farewell to arms
Most discussions of how fiscal policy relates to the outlook
rightly focus on the discretionary stimulus measures. However, there are other moving parts when it comes to fiscal
policy. One that will become increasingly important for the
US economy is defense spending. The winding down of
military operations in Iraq and Afghanistan could contribute to a decline in defense spending of about 1/4%-point of
GDP this year, and then a contraction of about 1/2%-point
in both 2013 and 2014. The regional recessions in California and New England in the early 1990s serve as a reminder
that welcome foreign policy developments can sometimes be
accompanied by painful economic transitions.
Estimating the impact of these developments is made a little
more difficult by the fact that the CBO’s baseline estimate
for these Overseas Contingency Operations (OCOs) must
assume a continuation of the troop levels in the prior fiscal
year, even though most observers expect the ongoing drawdown of troops in the Mideast will continue. To allow for
this possibility, CBO also constructs an alternative scenario
whereby troops in that region are gradually decreased, and in
that scenario defense spending declines in a similar manner
to that in the OMB forecast—which is allowed to make more
realistic assumptions concerning defense policy.
And in summation...
The first two sections of this note discussed the fiscal cliff
and our expectation that only a fraction, perhaps one-fifth,
of that cliff will be realized. The last section discussed noncliff issues, focusing on fading stimulus and declining defense spending. The table at the bottom of the first page
puts this all together into one measure of the expected impact of fiscal policy on the economy. In order to translate
deficits into fiscal thrust, one needs to remove the swings
to the deficit caused by automatic stabilizers, where
changes reflect economic developments. In addition, TARP
outlays (on a subsidy cost basis) reflect financial rather
than real transactions and should be removed. Changes in
the resultant structural deficit represent the fiscal thrust or
drag from federal fiscal policy. We have mostly avoided
the issue of fiscal multipliers, but applying a fairly middleof-the-road multiplier of 1.0, the table implies a drag of
1.4% on GDP growth next year. Of course, if the cliff is
not dealt with the drag could be more than twice as large.
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