While the so-called fiscal cliff could thrust the country back into recession, policy stalemate in Congress is already taking a toll on the economy.
"Uncertainty about the resolution of fiscal policy early next year is weighing on the economy," says Congressional Budget Office Director Doug Elmendorf. "Even beyond the cliff itself, uncertainty about how we are going to resolve the fundamental inconsistency between our spending plans and our tax plans is weighing on households and businesses." [Read: Where Taxes are Already Going Up.]
Elmendorf says without a clear signal from Capitol hill about how legislators will proceed, everyone from government agency heads to contractors are proceeding with extreme caution.
"CBO is a very small piece of the federal government, but our own decisions about whether to replace people who leave is affected by the uncertainty of what our funding will be next year," Elmendorf says. "And I think that must play out in a much, much larger scale with more significant enterprises than ours."
During the debt ceiling debacle last summer, Congress set automatic spending cuts in place to force an agreement by the so-called super committee, a group of legislators saddled with the task of hammering out a deal to rein in the national debt. Their failure to find common ground then triggered $1.2 trillion in across-the-board spending cuts scheduled to take place on Jan. 2, 2013.
Steven Davis, deputy dean at the University of Chicago Booth School of Business, studies the effects of policy uncertainty on the economy and agrees with Elmendorf that the threat of looming sequestration, expiration of the Bush-era tax cuts, and the threat of an upcoming debt ceiling crisis are likely affecting the economy now even though none of them have actually occurred.And since stock markets dread uncertainty, Wall Street has already settled into a period of extreme volatility. [See: Latest political cartoons]
"It would be helpful to the economic prospect if the Congress created greater clarity about the policy environment and specifically the policy environment related to taxes," Davis says.
While he recognizes that it is highly unlikely that either Republicans or Democrats would develop a bipartisan solution before or during a lame duck session of Congress, Davis suggests both parties vote to push off the fiscal cliff by a few months to create a little stability for businesses and government agencies.
"That way whichever party comes out on top after the election will have time to make more permanent, long-term tax and spending policies," Davis says.
The politics of an election year have historically handicapped Congress, but experts say this time around legislators cannot let politics keep them from completely giving up on their jobs.
"The number of things that are hitting at the end of the year are so many that it is hard to imagine that you would wait it out and then begin to work after the election," says John Fortier, director of the Democracy Project at the Bipartisan Policy Center. "What Congress should be doing is working, planning, and thinking behind the scenes about possible outcomes. It is not so simple to cut a sequester deal in three weeks."
Yet neither party has an incentive to come to an agreement now.
Republicans are holding out on a long-term solution until they see if they gain the White House or can win a majority in the Senate.
And Democrats, are holding out to see if they can take control of the House of Representatives while keeping President Barack Obama in the White House.
"You have the real possibility of shifts in both the Senate and the presidency. Everyone knows that something new might be coming and they know a new set of players could come in, Fortier says. "They all want to see deals made on their terms."
Even if both parties play a game of chicken on "taxmagedon," Republicans and Democrats could help ease economic distress by showing that they are at least engaged in conversations about sequestration and tax reform.
"One serious signal would be to show committees on both sides are working on options and have some plans in mind and sure the election might push them one way or another, but they are working behind the scenes," Fortier says.
"What I worry about most is that our political system needs to come to grips with this fundamental choice about whether we are going to let taxes rise, relative to what we are used to in the past, or cut spending on the big, popular entitlement programs," CBO Director Elmendorf says. "I think they will, but I worry about how long it will take for those decisions to be made and the effect a delay will have on the budget future and the economy now."
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