The Case for Heading Over the Fiscal Cliff

So what if we went over the fiscal cliff?

Crazy as it sounds, some in Washington and on Wall Street are beginning to ponder whether it would really be so bad to let the pending $607 billion in tax increases and spending cuts take effect in January 2013.

The Congressional Budget Office has warned that failure to deal with the spending austerity and expiring tax cuts will plunge the U.S. back into recession, with the economy contracting at an annual rate of 1.3 percent in the first half of next year.

But there’s a silver lining to going off the cliff: The U.S gets its short-term budget deficit under control, bringing down debt from an estimated 76 percent of gross domestic product in 2013 to 58.5 percent by 2022. It also gives lawmakers -- particularly Republicans -- a bigger pot of revenue from which to start tax-cut discussions.

What ultimately happens depends entirely on the election, and armchair strategists disagree about whether a newly elected Mitt Romney or a re-elected Barack Obama stands a better chance of making a Grand Bargain. Obama said this week in an interview with the Des Moines Register editorial board that he’ll pursue a debt deal within the first six months of a second term. As my Bloomberg News colleague Richard Rubin has reported, congressional Republicans are discussing options for a post- election deal but are far from being solidified. House Speaker John Boehner has said he’s “not confident at all” in the ability to strike a post-election deficit deal.

Republicans may simply be bluffing in an attempt to convince voters that real deficit reduction will only happen if Romney is elected. But it may not be disingenuous.

Here’s why: Any tax and spending deal Obama puts forward will include new revenues (i.e. higher taxes) that Republicans oppose. Obama wants to let the Bush tax cuts expire for the wealthiest and may, along with congressional Democrats, push for other revenue raisers. Democrats and Republicans also disagree on defense cuts included in the so-called budget sequester.

Could Republicans simply cross their arms and refuse to agree to a deal? It’s possible. They would simply blame Democrats for allowing taxes to increase on everyone (not just the wealthiest) and then claim credit for any subsequent -- and inevitable -- deal to cut taxes. Deutsche Bank AG chief economist Peter Hooper, in an interview this week with Bloomberg, said going over the cliff is “an inefficient way of dealing with revenues” but that the markets - - after suffering a near-term hit -- could be buoyed by the fact that the U.S. has dealt with its crushing debt load.

Still, the negatives probably outweigh any positive effect of heading down the cliff. In 2008, Republicans were all set to let the emergency financial bailout bill die -- until the stock market plunged 700 points. No one knows exactly how the markets will react to failure to get a fiscal cliff deal.

But given the recent pleas from business leaders to come to agreement, one can guess the reaction will make the near- collapse of TARP in 2008 seem like a day at the park. And that, more than anything else, could prompt some compromise.

(Deborah Solomon is a member of the Bloomberg View editorial board. Follow her on Twitter.)

Read more breaking commentary from Bloomberg View at the Ticker.

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