Personal Wealth Management / Market Analysis

Scaling the Fiscal Cliff

As the election nears and the year winds down, fiscal cliff rhetoric is heating up. So how to read between the hype’s lines?

The so-called fiscal cliff has seemingly taken center stage again recently. (See our past writings on it here, here, here, here or here.) Since the media’s a for-profit business and not a charity, it will undoubtedly continue doing its utmost to wring all it can from this very compelling story. So before getting swept away by fears we’ll plummet over the cliff on January 1 and face near-instant recession, here are some important, objective facts to keep in mind whenever contemplating the so-called cliff that is allegedly fiscal.

First, let’s talk about the sheer size. Recall how we got here: Because the “Super Committee” couldn’t agree last year on spending cuts, as of January 1, 2013, $1.2 trillion worth of automatic “spending cuts” will commence, to be spread over the ensuing nine years. Baked into that $1.2 trillion is the assumption we’ll save approximately $216 billion in debt service payments over the same period, so the actual “cuts” required total $984 billion, not the full $1.2 trillion. Divided by nine years, that’s roughly $109 billion in cuts annually, generally to be split evenly between defense and non-defense spending (so, roughly $55 billion apiece). Still sounds huge! A 55 with nine zeroes after it!

But an important tactic whenever thinking about such enormous numbers is scaling—putting the number in some sort of context that helps you determine whether it really is a big number relative to something else. So let’s scale the sequestration numbers and see what we get.

Projected total government outlays for fiscal year 2013, according to the Office of Management and Budget (OMB) are $3.803 trillion. Since that’s for the fiscal year, which runs from September to September, we need to adjust a touch—so the government’s projected to spend some $2.85 trillion between January 1, 2013, when sequestration kicks in, and September 30, 2013, when the fiscal year ends (quite simply, ¾ of projected 2013 fiscal year spending).

Doing the same thing to the sequestration number (assuming it’s spread evenly over 12 months), roughly $82 billion would take place by the end of September. And now we can divide: $82 billion divided by $2.85 trillion is roughly 2.9% of total government spending. Sounds much less menacing, doesn’t it?

Now doing the same for GDP—which is projected to be $16.34 trillion in fiscal year 2013—sequestration amounts to 0.67% of projected GDP. A hit of that size wouldn’t be terrific, but it’s not utter disaster. And it’s a far less scary number than $1.2 trillion, as the media commonly bandies about. And that’s if the fiscal cliff plays out exactly as currently feared. More on that in a bit.

Then there’s the tax increase side of the equation. For example, payroll taxes are set to increase two percentage points, which in theory hurts “middle class families” (however defined) most. But consider that personal incomes have risen nearly $450 billion over the last year, and a rather small increase that likely amounts to somewhere between $1000 and $2000 or so over an entire year ($80 to $150 per month) also seems less insidious.

We won’t go through the same exercise with all the other taxes here. Though it’s important to note we’re definitely not of any tax increases, and it’s certainly possible we see some short-term dislocations should all the aspects of the “fiscal cliff” kick in. But consider the fact markets have known for nearly a year now sequestration and tax increases were coming, yet the economy and markets have overall continued growing over that timeframe.

Then, too, nothing’s written in stone. Yes, Congress tried to pull an Odysseus and lash itself to the mast of spending cuts, but that’s more of a publicity stunt than a reality. The reality is all of these things can be changed rather easily legislatively. And politicians needn’t even lose much face doing it—all they have to say is rather than impose undue pain on Americans at a time of continued economic recovery (a stretch since the economy’s been growing for nearly four years now, but never mind), they’re going to put any spending cuts off two years. Or four. Or (even better!) until it’s more “economically realistic”—which will probably be never, by politicians’ count. Or or or! Politicians play those games all the time.

They also do things like narrowly define whose spending will be sequestered—though that’s not the story the media’s telling. For example, sequestration won’t apply to so-called mandatory spending. Which, according to the Bipartisan Policy Center, includes Social Security, retirement programs, veterans’ benefits, refundable tax credits, Medicaid, the Children’s Health Insurance Program, unemployment insurance, food stamps, Temporary Assistance for Needy Families and many other programs, mostly aimed at low-income individuals. So ... what exactly will be sequestered?

If all that doesn’t convince you the fiscal cliff is largely a mirage the media’s seeing, here’s a final consideration: As we’ve argued many times on MarketMinder, the far more significant originator of economic activity, innovation and growth is the private sector, not the government. So in our view, cutting government spending, even in a potentially sudden manner (if you call a year-plus’s lead time “sudden”—and, as a side note, the spending cuts would not be implemented all at once anyway), in the long run, frees more resources for the private sector’s use—and throughout history, the private sector’s proven its superior efficiency and productive capacity.

So don’t let yourself get swept up in the fiscal cliff hype—there are just too many mitigating factors that likely get in the way. Including politicians’ tendency to look out first and foremost for their own re-election potential. And if there’s one thing never to discount, it’s politicians’ capacity for self-interestedness.

If you would like to contact the editors responsible for this article, please message MarketMinder directly.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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