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What Does the Fiscal Cliff Deal Mean for Growth?

February 1, 2013 5 minute Read by Matthew Denhart

Many Americans are wondering what the fiscal cliff deal will mean for economic growth this year and beyond. The overriding consensus from experts seems to be that while the deal averted potential short-term disaster — i.e. a probable recession in 2013 — it did nothing to improve the longer-term growth outlook. Of particular concern among economists is the threat that entitlements pose to growth. Below are some interesting articles from leading economic thinkers: This article from the January 5, 2013 edition of The Economist refers to the fiscal cliff ordeal as “America’s European moment.” The British magazine bemoans that Washington’s actions show that, like Europe, the U.S. is prone to the political preference for short-term can-kicking over solutions that actually solve long-term fiscal challenges. Something particularly disturbing about the fiscal cliff deal, The Economist writes, is that “It did nothing to control the unsustainable path of entitlement spending on pensions and health care (the latter is on track to double as a share of GDP over the next 25 years); nothing to rationalise America’s hideously complex and distorting tax code, which includes more than $1 trillion of deductions; and virtually nothing to close America’s big structural budget deficit.” A second article from The Economist offers a more specific estimation of the deal’s effect on economic growth this year: “…federal fiscal tightening will, economists think, amount to 1-1.5% of GDP in 2013, with most of that contraction felt in the first half of the year.” Meanwhile, the article reasons, the ongoing housing market recovery, steady U.S. employment growth, and a less dire economic situation in Europe give us some reason for optimism. These factors, the article says, “may be enough to sustain economic growth near 2% or better.” Even so, we clearly still have a far way to go to achieve the Bush Institute’s goal of 4% annual growth. Amity Shlaes, director of the Bush Institute’s 4% Growth Project, blogs that the real cost to growth may come from the dampening of individuals’ aspirations. Shlaes worries that as marginal tax rates increase, “People who have spent long years investing personal capital in learning their profession will see their capital eaten away by the new high income tax. They will become cynical.” Shlaes writes, “Many economists will focus on the capital gains and dividend treatment.” These are important areas to be sure, but she concludes by saying, “My own interest is in quantifying the cost that the new cynicism imposes on economic growth.” Ike Brannon, a fellow of the Bush Institute, writes that the true cost of the fiscal cliff deal is that it failed to build political momentum that might have produced a more comprehensive bargain between the political parties in 2013 on taxes and entitlements. Brannon sees these two issues as the most important areas where reform could yield stronger growth. Fareed Zakaria, in a column for the Washington Post, also faults the fiscal cliff negotiations for failing to address entitlement reform. Zakaria believes that entitlement reform is crucial in order to free up government revenues. Such revenues could then be spent on investments, such as infrastructure and human capital, that would yield stronger long-term growth. Finally, George Will, also writing in the Washington Post on the theme of investment, argues that a major problem with today’s federal deficit spending is that it funds current consumption, rather than investment that will benefit future generations. Will cautions that the fiscal cliff was just a first glimpse of the cost of the entitlement state. He draws three lessons from the negotiations: First, spending restraint from Washington is unlikely. Second, we should be worried about current policies and political attitudes because they are making sluggish growth “normal.” Third, Will believes “one December winner was George W. Bush” since his tax cuts became permanent for nearly all Americans. This post was written by Matthew Denhart, research assistant to the 4% Growth Project at the George W. Bush Institute. Previously he served as administrative director of the Center for College Affordability and Productivity.


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Matthew Denhart
Matthew Denhart

Matthew Denhart is an expert on immigration policy and is the author of the Bush Institute’s America's Advantage: A Handbook of Vital Immigration and Economic Growth Statistics, now in its third edition. He currently serves as executive director of the Calvin Coolidge Presidential Foundation and is a founder of the Coolidge Scholars Program which provides full-ride merit scholarships to America's most promising college students. A summa cum laude graduate of Ohio University, Denhart has written and spoken widely on a variety of policy topics including the economics of higher education, labor, and taxes. He has contributed articles to numerous national publications including The Wall Street Journal, Forbes.com, CNN Opinion, and Bloomberg View. 

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