The United States should get ready to go off the fiscal cliff.
Without congressional action, broad tax increases and spending cuts will automatically take effect on January 2. The Bush-era tax cuts, the Alternative Minimum Tax patch, and the temporary payroll tax reduction will expire. The extension of unemployment benefits will lapse, and payments to physicians under Medicare will be reduced. And, of course, the sequestration mechanism contained in last year's Budget Control Act will cut planned defense and domestic discretionary spending by about $1 trillion over the next 10 years.
The combined effect of deep spending cuts and substantial tax increases would remove more than $600 billion from the economy in 2013 and send the United States back into recession. The Tax Policy Center estimates that taxes on the average middle-income household would increase by nearly $2,000. And the Congressional Budget Office projects that, if we go off the fiscal cliff, U.S. gross domestic product would shrink by 0.5 percent (instead of growing by 1.7 percent) and unemployment would reach 9.1 percent (instead of 8 percent).
The national security establishment has focused primarily on the potential cuts to the Pentagon, which would total some $500 billion over the next decade. In their third debate, Mitt Romney warned Barack Obama that such cuts would devastate the military, leading the president to promise: "It will not happen." But the likelihood of cuts to defense spending cannot be considered in isolation from all the other elements of the fiscal cliff, and with the election behind us, it's time to admit there is a strong possibility that sequestration will take effect -- because both the president and Congress could benefit politically.
Just consider the likelihood of these three scenarios:
Scenario 1: Congress and the president agree to a grand bargain.
Although structural factors seem to favor a deal, the 112th Congress's political gridlock -- it has passed the fewest laws of any session since World War II -- as well as the extremely short time available to forge a large, complicated piece of legislation almost certainly means that Congress and the president will not strike a grand bargain before January 2.
At first glance, the prospects for such a deal seem higher than at any point during the past two years. President Obama's bargaining power has increased now that he has received a clear mandate for the next four years. Additionally, allowing tax breaks to expire means that taxes will increase, which many Republicans oppose. For their part, Democrats want to prevent large cuts to domestic discretionary spending, and they have an incentive to cut a big deal before the nation hits the debt ceiling again, likely early in 2013. Leaders from both parties oppose the sequestration defense cuts. And, of course, neither side wants the country to plunge back into recession.