Could 'Taxmageddon' Crisis Create Compromise?

On Jan. 1, trillions of dollars in spending cuts and tax increases — called Taxmageddon — will take effect unless Congress and the White House can agree on a new plan. Many economists say the country will fall back into a recession if it happens. Former Treasury Secretary Robert Rubin says Congress may actually be "forced to make a decision that affects taxes and spending."

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GUY RAZ, HOST:

It's WEEKENDS on ALL THINGS CONSIDERED from NPR News. I'm Guy Raz.

Spain is about to join Greece, Portugal and Ireland as the latest eurozone country to ask for a bailout. Spain's banking sector is in crisis, largely because many of those banks have lost billions of dollars on bad loans stemming from a real estate bubble. The Spanish government could ask the European Central Bank for as much as $125 billion to help stabilize its financial sector. It's another sign of growing economic uncertainty in Europe, uncertainty that could have ripple effects here.

And we'll explore some of that domestic turmoil in our cover story today: the fiscal cliff and a possible return to recession. In a moment, former Treasury Secretary Robert Rubin on why we face a tough six months ahead, but first to a scenario that if left unresolved will almost certainly plunge the U.S. economy back into recession.

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RAZ: By December 31st, Congress and the White House must come to an agreement about taxes ad spending. Otherwise, a series of triggers will slash spending and raise taxes for almost everyone. Some call it taxmageddon, others know it as the fiscal cliff. Here's NPR's David Kestenbaum from our Planet Money team with more.

DAVID KESTENBAUM, BYLINE: So the fiscal cliff is a combination of spending cuts and tax increases that are set to kick in like midnight December 31st, like a very specific time. The good news is that in a stroke, they would go a long way toward reducing our budget deficit. The bad news is that they would probably, in the short term, slow our economy down significantly and throw us back into a recession. The economy would actually shrink, get smaller for the first half of the year. That's according to projections by the Congressional Budget Office. So that's what people are talking about when they're talking about the fiscal cliff.

RAZ: OK. So what specifically now would happen - is supposed to happen - on the 31st of December?

KESTENBAUM: It is a remarkable collection of problems basically Congress has put off and not dealt with, and they've all kind of piled up. And so it's a real mix of things. There's the - the Bush-era tax cuts are set to expire. There's a 2 percent payroll tax break for all of us that will expire. There are also automatic spending cuts that are set to take place because, remember, the supercommittee that was supposed to reach some bipartisan agreement to reduce the debt - that totally failed.

So taken together, all these things - it's just - it's amazing. If Congress doesn't do something - I can't think of another time when if Congress didn't do something, like the deficit problem would be halfway solved.

RAZ: Such a perfect storm, David, that if nothing is done, the Congressional Budget Office estimates we will go back into recession early next year.

KESTENBAUM: Yeah. The first half of the year, the economy, they say, would shrink. And it would grow in the second half of the year. But basically for the year, not much happens, total growth of the economy for the year, they said, is like half a percent, which is a bad year.

RAZ: Is there anybody who wants this to happen?

KESTENBAUM: No. And, in fact, if you ask me what happens with the cuts, nobody really knows because they're just scheduled to kick in and everyone figured it wouldn't happen, you know? Half of them are going to military, half are for discretionary programs. Basically, half are for programs Democrats like and half are for programs that Republicans love, and no one's really thought through how to do it because they all assumed it wouldn't happen. But now, we're really heading toward the cliff.

RAZ: That's NPR's David Kestenbaum from our Planet Money team. Now, the Congressional Budget Office estimates if these issues are not resolved, more than $600 billion could be sucked out of our economy. But former Treasury Secretary Robert Rubin believes the deadline could actually create an opportunity for an important compromise.

ROBERT RUBIN: You have a situation that I cannot remember, at least in my adult lifetime, where Congress is actually forced to make a decision that will affect taxes and spending. Because if they do nothing, then taxes go up substantially and the mandated reductions in spending, the so-called sequester, goes into effect. So that's if they do nothing. And then the alternative would be to act in either of two ways. This is a broad brush.

They could simply kick everything down the road. So there, their acting is affecting taxes and spending. And, two, they could do what would be an enormous interest to the nation, which is to come together and reach an agreement on a sound fiscal program that addressed our long-term problems, probably the implementation should be deferred for a couple of years, and I think it could create a lot of confidence now.

So for all those reasons, plus the fact that you'll be right after an election and the next election will be the furthest away that you can possible get, which is approximately two years, it seems to me that this is a propitious time, a time when there is a very special potential opportunity for the system to work. Now, whether we realize that potential or not, of course, and then we function with what Congress does.

RAZ: It seems the main argument is between those who back austerity and those who back greater spending. That is the basic argument right now. Where do you think you would fall on that spectrum?

RUBIN: I think that's a false choice. It's not the way I would frame the debate. You're correct in what you say. The debate seems to be between those who say, let's focus on jobs and growth on the one hand, and let's focus on deficit reduction - I wouldn't call it austerity - deficit reduction on the other hand. I think if you put in place a program today that was a sound fiscal program, it phased in deficit reduction over, say, a 10-year period.

It got us to the point where the ratio of debt to GDP was stabilized, and included in it room for significant public investment, the implementation was deferred for a couple of years so that you give our recovery more time to get traction, I think it would have two effects. Number one, in the short term, I think it would significantly increase confidence because, I think, business confidence is substantially undermined by uncertainty over future policy and also about real concern whether we are able to govern.

So I think in the short term, it probably would contribute significantly to economic growth. And then over the longer term, it would address what is a unsustainable and dangerous fiscal position.

RAZ: Robert Rubin, let me ask you about the overall economy right now. We have bad jobless numbers come out last week, just a series of bad economic stories coming out of Europe. It doesn't seem to be getting any better. Are you optimistic about where the economy is headed right now?

RUBIN: I've consistently had the same views since the beginning of the year. When the numbers were better and a lot of analysts had increased their projections, my view was that we face enormously strong headwinds. And now as the year has progressed, the numbers have deteriorated and the analysts who had increased their estimates are now reducing them back to lower levels.

And I think as you look forward, I think we face, in addition to the headwinds that were there before, we now have two additional factors. One of them is what's happening in Europe, and I think that's deeply troubling and certainly could affect confidence here and have various other effects here. And secondly, we have the so-called fiscal cliff at the end of this year. And I think there's the likelihood that as business and the markets focus more and more on what Congress' responses might be, that will create additional uncertainty. And that uncertainty could also have an adverse effect both on the economy and the market.

So I think the likelihood is that the next six months are going to be a relatively difficult period. Certainly not a double dip, but nevertheless, a relatively difficult period.

RAZ: That's Robert Rubin, the Treasury secretary under President Clinton and now the co-chair of the Council on Foreign Relations. Secretary Rubin, thank you so much.

RUBIN: You are more than welcome.

RAZ: Now, according to Chad Stone, the chief economist for the Center on Budget and Policy Priorities, December 31st is somewhat of an arbitrary deadline. He says the idea that the economy will somehow plunge into darkness on January 1st is not entirely accurate.

CHAD STONE: This is being called the fiscal cliff, but that conjures up in policymakers' minds something that is misleading and dangerous, which is that the economy, all of a sudden, has a Wile E. Coyote moment where we find ourselves out over the cliff and plunge immediately into a deep recession on - in the first week of January. That's not what's going to happen.

The Congressional Budget Office has estimated that the economy would go into recession if policymakers let all of those changes take effect for the entire year. But it takes time for that to get going. And so in the first couple weeks, we're starting down a slope. The slope gets increasingly steep if we don't take any policy action, but policymakers are very unlikely to let that happen.

RAZ: If you say we are not hurdling towards a fiscal cliff, as some economists have said, in January, how would you describe what we are headed towards?

STONE: We're heading to a decision point, and if we fail to make the right decisions, we could end up with the worst of both worlds rather than addressing both problems. We could end up with contraction in the economy and with not having addressed the budget deficit.

RAZ: That's Chad Stone from the Center for Budget and Policy Priorities. So on top of potential tax hikes and dramatic spending cuts that could happen on January 1st, add one more thing: the debt ceiling limit, remember that? Last August, the White House and congressional Republicans agreed to raise the amount of money the U.S. government could borrow at the very last minute.

It resulted in a downgrading of America's credit rating by Standard & Poor's. Well, that drama may unfold once again early next year when the government hits its borrowing limit of $16.4 trillion.

Betsey Stevenson has been writing about this scenario. She's an economist at the Wharton School of Business. And she says the last time around, the consequences were serious.

BETSEY STEVENSON: What we saw was consumer confidence plummeting. And it fell enormously from the time that Congress started saying they might not raise the debt ceiling up until the very last minute when it actually was raised. And if you look at what happened with hiring, it looks like employers said, hey, I'm not going to hire right now. I don't know what the heck's going to happen.

If you think about that and apply it to this year's context, if I was a business owner trying to make decisions about what my company needed to do to be prepared for sales over the next year, I would think, well, there's a real risk that the U.S. is going to go into recession. And if we go into recession, I'm going to need fewer workers.

So why should I pay the up-front costs of hiring new workers today if I'm going to end up having to lay workers off in January, February or March. That will start to slow down hiring. The greater the chances are of us going into a recession in early 2013, the more it becomes a self-fulfilling prophecy.

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RAZ: Betsey Stevenson, she's an assistant professor of business and public policy at the Wharton School of Business. And on that depressing note, we promise a little light later on. What do James Franco, Katy Perry, the Harvard baseball team and President Obama all have in common? They've all been swept in the "Call Me Maybe" phenomenon. How that song became the song of the summer. Stay with us. You're listening to ALL THINGS CONSIDERED from NPR News.

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