Dec.JEC Holds Hearing on the Fiscal Cliff

AT TODAY’S JOINT ECONOMIC COMMITTEE HEARING, members discussed the looming fiscal cliff, the Republican and White House proposals to address the issue, and the potential impact to the U.S. economy with Mark Zandy, Chief Economist with Moody’s Analytics, and Kevin Hassett, Senior Fellow and Director of Economic Policy Studies at the American Enterprise Institute (AEI). 

Chairman Bob Casey (D-Pa.), in opening remarks, strongly urged that the payroll tax cut be kept in place at 4.2 percent and advocated for extending current rates for the middle class. Casey cited a recent Congressional Budget Office (CBO) report, which said this measure would boost Gross Domestic Product (GDP) growth by 1.3 percent next year and create 1.6 million jobs. 

Rep. Michael Burgess (R-Texas) said “President Obama has the responsibility to propose a real, bipartisan plan to avert the fiscal cliff that can pass both the House and the Senate.”  Burgess suggested that Republicans “would likely react favorably” to a plan put forth by the president that draws from the recommendations made in the Simpson-Bowles proposal. 

Burgess criticized the president’s current proposal, specifically pointing to the new round of stimulus spending embedded in the proposal and the lack of any mention of entitlement reform in the proposal. Using a prior AEI study on fiscal consolidation proposals implemented across various countries, Burgess stated that proposals which contain a higher ratio of revenue measures versus spending reductions ”do not result in successful outcomes.” 

In his opening statement, Zandi called on Congress to address the fiscal cliff, the debt ceiling, and to achieve long term fiscal sustainability. “Those three things need to be done now,” he said. Zandi estimated that if current policy is left unchanged and Congress is unable to come to a consensus, then the U.S. economy will see a 3.5 percent drop in GDP, pushing the U.S. into a “severe recession.”  

In his remarks, Zandi advocated for scaling back the potential fiscal cliff impact to 1.5 percent of GDP. Anything more than this will be considered “counterproductive,” according to Zandi, as the economy will weaken and the budget will deteriorate further.  He suggested extending both the unemployment insurance program and “some form of a payroll tax holiday.”  

Notably, Zandi also suggested that Congress do away with the debt ceiling limitation. In its place, “we need new budget mechanisms to ensure budget discipline,” including PAYGO and consideration of “some version of a dollar for dollar rule,” Zandi said. He called the current debt ceiling law “a mess” in that it undermines the U.S. economy. 

Zandi called for $3 trillion in deficit reduction over a ten year period. Of that amount, $1.4 trillion would come from tax revenue (higher rates and tax reform), $1.2 trillion would come from cuts to various programs including entitlements, and $400 billion would come from net interest savings. Add in the estimated cuts from the Budget Controll Act of 2011, and the real deficit reduction figure is more than $4 trillion over ten years, according to Zandi. Additionally, the ratio of spending cuts to revenue increases would be 2 to 1, he said. 

Finally, Zandi said the fundamentals of the U.S. economy “are in very good shape,” but strongly urged Congress to come to an agreement. “You have got to nail this down, uncertainty is killing us,” he said. 

In his opening remarks, Hasset agreed with Zandi that the near term economic impact from going off the cliff would be “significant” and “would throw us into recession.” That being said, Hasset cautioned Congress from “kicking the can down the road” and putting off tough decisions. He added that a continuation of today’s policies would hurt economic growth in the future. 

Using a prior study that Hasset coauthored with two other AEI employees, Hasset called for a deficit cutting proposal composed of an 85 to 15 ratio between spending cuts and revenue increases.  

The study found that fiscal consolidations weighted more towards spending reductions were much more successful than those weighted in favor of tax increases.  

During the hearing, Zandi disagreed with Hassets ratio, noting that the spending multipliers “are very large” and suggested a 2 to 1 ratio to put the U.S. in “a reasonably good place.” 

Question and Answer 

Casey asked Zandi what programs have the biggest “bang for the buck” in terms of economic impact, to which Zandi said if the extension of the tax rates for those making less than $250,000 were taken as given, then unemployment insurance and the payroll tax holiday are effective programs. 

Hasset disagreed calling both programs short term measures which further exacerbate the current uncertainty out there since Congress has to continually extend the programs. Rather, Hasset suggested dealing effectively with the big issues to provide clarity to the business community that would dwarf any upside provided from slight changes to those programs. 

Zandi agreed with Hasset in that “we do not want to get into a cycle of dependency,” and temporary measures need to be phased out over time. “All I’m arguing is to smooth-in the fiscal drag,” he said. 

Budget Math 

Rep. Carolyn Maloney asked Zandi to outline the difference between both the White House and House Speaker John Boehner’s (R-Ohio) deficit reduction proposals. On the revenue side, Zandi said the president’s proposal generates $1.6 trillion towards deficit reduction over ten years composed of tax reform measures and the implementation of higher tax rates. The Boehner proposal contains roughly $800 billion from tax reform. Noting that the two plans are $800 billion apart, Zandi said he would propose a plan that called for $1.4 trillion in tax revenue with $700 billion from tax reform  and $700 billion from higher tax rates. 

On the spending side, President Obama’s proposal calls for $600 billion in spending cuts over ten years with $350 billion in cuts to Medicaid and $250 billion in cuts to agriculture subsidies and other programs. As for Boehner’s proposal, “it is unclear how much the spending cuts will add up to.” 

Reflecting on the numbers, “I think the president’s proposal is short,” Zandi said, adding that the U.S. needs at least $1.2 trillion in spending cuts. The president needs to look more at entitlement reform and include social security in his proposal, Zandi said. 

Rep. Mick Mulvaney (R-S.C.) ran through the above numbers, and questioned Zandi about the 2 to 1 ratio figure between spending cuts and revenue increases. Mulvaney said since the Budget Control Act has already been baselined, “you would only get a 1 to 1 ratio instead,” and pressed Zandi whether the current White House proposal meets the 2 to 1 ratio.  

“No, it’s short,” Zandi said. He added that President Obama needs to come up with an additional $600 billion in spending cuts over ten years. 

Sen. Pat Toomey (R-Pa.) questioned the $600 billion in spending cuts proposed in the White House plan. He mentioned that $200 billion of that amount was based on fees, and coupled with additional stimulus spending, the “doc fix,” and deferring the sequester, the $200 billion amount rises to $400 billion, which should be deducted from the $600 billion since those funds “are not spending restraint at all.” Putting the $1.6 trillion in revenue up to the now $200 billion in spending cuts, you get an 8 to 1 ratio, he said.  

Hasset said the president’s proposal “would fail,” based off his findings from the 2010 study. With high individual income tax rates, the highest corporate tax rate in the world, and the potential for skyrocketing taxes on dividends, “in that kind of world it is impossible to envision generating the kind of healthy economic growth that would ever make us willing to have those spending cuts that we promised to do two years from now,” Hasset said. 

Economic Impact 

Toomey noted that with the president’s proposed tax hikes at the federal level, in addition to state taxes, “some Americans will be paying more than half of their income. Their marginal income tax rate would exceed 50 percent.” He asked Hasset whether this would likely cause a recession. 

Hasset agreed, and stated that the dividend tax alone “is positively cataclysmic…. That’s ridiculously bad news for equity markets,” he said. 

Regarding business investment, Vice Chairman Kevin Brady (R-Texas) asked Hasset whether he believed raising taxes on the two marginal rates, as well as capital gains and dividends, encourages more business investment.  

Hasset said these measures will lead to a significant drag on the economy. “The fact is that dividend taxes, capital gains taxes, statutory tax rates, have a big affect on investment through the user cost of capital. If the dividend tax is going to go up, then there are a lot of firms that are going to be hurt significantly by that and day-today would be pairing back their capital spending in anticipation of higher taxes in the future.” 


Sen. Amy Klobuchar (D-Minn.) asked about the timeframe until the market reacts negatively and downgrades occur. Zandi suggested the debate “could go into next year….” He added, “I would counsel not coming up with a deal unless it’s a really good deal before the end of the year. I would take it into next year if that means you’re going to get a better deal” that would solve the fiscal cliff, raise the debt ceiling, and achieve long-term fiscal sustainability, as Zandi pointed out in his opening remarks. 

In a response to Rep. Elijah Cummings (D-Md.), Zandi said Congress has until early February to get a deal done. “You’ve got about a month…. By mid-February it would be doing a lot of damage,” he said. This timeframe would depend on whether or not the Department of Treasury can freeze the withholding tables. “If they can’t, the damage will amount faster. You won’t have as much time,” Zandi said. 

For more on the hearing, please click here.