Let's jump off the fiscal cliff - The Term Sheet ... - Fortune Finance

By John Cassidy, contributor

FORTUNE -- With the election almost upon us, Wall Street is starting to focus on the possibility that, come Jan. 1, 2013, the economy could hurtle over a "fiscal cliff" consisting of $600 billion in tax increases and spending cuts. It's hard not to be concerned. The Congressional Budget Office and Ben Bernanke have warned that this shock -- a result of the Bush tax cuts and the Obama payroll tax reductions expiring at the same time that automatic spending cuts are imposed -- could well plunge the economy into another recession. But before we all panic and agree to another meaningless short-term fix, such as the one that some senators from both parties are reportedly discussing, let's consider another possibility. Crazy as it might sound, the expiration of the tax cuts could turn out to be a blessing in disguise.

For years, Democrats and Republicans have been arguing about how to reduce the enormous budget deficits that have emerged partly as a consequence of the Great Recession. Over the next decade, both sides agree, we need about $4 trillion to $5 trillion in spending cuts and revenue increases. But nobody can agree on how to do the split -- particularly how to raise federal revenue, now less than 16% of GDP, the lowest level since the early 1950s. President Obama and the Democrats refuse to consider tax hikes on anybody earning less than $250,000 a year. Republicans in Congress refuse to countenance any hikes at all.

MORE:?PIMCO's El-Erian: We're very worried about the?fiscal cliff

Allowing the tax cuts to expire on schedule potentially provides a way out of the impasse. According to Bill Gale of the Brookings Institution, who supports the idea, it would raise about $2.8 trillion over the next 10 years -- more than enough to help bring down the deficit and stabilize the ratio of federal debt to GDP, a key indicator of long-term financial stability. "Going over the cliff is the only way to get the economy on a good long-term budget path with a deficit-reduction package that balances revenue increases and spending cuts," Gale wrote in a recent article for the nonpartisan Tax Policy Center. Another cool thing about Gale's approach: It wouldn't require a single vote on Capitol Hill. If the lame-duck Congress does nothing at all when it meets after the election, the tax increases and spending cuts will go into effect on Jan. 1 -- and the threat of the U.S. eventually encountering a Europe-style debt crisis will be greatly reduced.

Now, as Milton Friedman taught us, there's no such thing as a free lunch. With the introduction of tax hikes and spending cuts, the threat of another recession early in 2013 would be very real. According to the CBO, the economy would contract at an annual rate of 1.3% in the first six months of next year. If Americans decide that the folks in Washington have lost it, and the markets panic, the outcome could be even worse. But there could also be a much better outcome. The next administration -- a reelected Obama administration, presumably -- could explain that it was merely reversing a set of policies that has put the U.S. on the road to ruin. Wall Street would be receptive. And -- this is key -- the administration could propose another short-term stimulus package to offset some of the hit to demand. Come late January, when the next Congress arrives in Washington, Democrats would be looking to roll back the tax hikes on the poor, and Republicans would be seeking to reverse higher levies on dividends and capital gains. Some targeted spending increases could also be discussed. In a debate about cutting taxes rather than raising them, a compromise would be likely, allowing a stimulus bill to be passed.

Admittedly, the idea of increasing taxes at the end of December only to cut them again in February or March takes a bit of getting used to. But as long as the new stimulus is relatively modest and temporary, it would all make perfect sense. The long-term fiscal outlook would be transformed, and the threat of a recession would be greatly reduced. In a dysfunctional political system such as ours, it sometimes takes unorthodox tactics to get important things done. This is one of those times. Bring on the fiscal cliff!

This story is from the October 29, 2012 issue of?Fortune.

Source: http://finance.fortune.cnn.com/2012/10/15/fiscal-cliff-jump/

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