Can the fiscal cliff push Congress to agree on budget deal?

This afternoon, I moderated an Urban Institute panel on taxes and the fiscal cliff. The fundamental question on the table:  Will Congress have to tumble over the precipice in order to build the political consensus it needs to do a budget deal?

To put it another way, will it take the fear of a financial market collapse and a cliff-driven recession to change the karma on Capitol Hill? Or, can Congress find an easier route to fiscal sanity by ducking the coming showdown?

There are huge dangers to both options, and no clear answer. But in the current political climate, it is hard to see a road to a long-term budget agreement, whether or not Congress falls over the edge. 

Lawmakers will reach taxmaggedon in just three months. The tax cuts enacted in 2001, 2003, 2009, and 2010 will expire absent congressional action. The Tax Policy Center estimates this would raise taxes by $500 billion in 2013 alone—an average tax hike of nearly $3,500 per household. At the same time, the automatic spending cuts adopted as part of the 2011 debt limit deal would kick in.

At today’s panel, Bob Greenstein, president of the Center on Budget and Policy Priorities, argued that tumbling off the cliff might sufficiently focus lawmakers’ minds to drive a fiscal agreement. While Bob was certainly not rooting for an end-of-the-year crisis, he felt that one, or at least its imminent threat, could encourage a two-part deal. Either in December (right at the edge of the precipice) or in early January, lawmakers would agree to forestall deep year-long tax hikes and spending increases in exchange for an agreed-upon target for long-term deficit reduction, including revenue-raising tax reform and cuts in entitlement programs.

In Bob’s view, the cliff is something more like a gradual—and reversible—slide. Thus,  a relatively quick deal in 2013 would limit the economic consequences of any short-term spending cuts or tax hikes.

Doug Holtz-Eakin, president of the American Action Forum and former top domestic policy adviser to the McCain for President campaign, disagreed. Doug insisted toppling over the cliff would throw the economy into recession. And, he added, Congress would never raise taxes or cut spending while the economy is dead in the water.  Thus, going over the cliff would be entirely counterproductive.

Doug’s alternative: Congress should extend today’s tax rules for all (including high-income households) and abandon the automatic spending cuts. Deficit reduction could still happen, he figures, once Washington feels pressure from Wall Street and the rating agencies to do a long-term fiscal deal.

To me, this creates a strange paradox. Doug is right that Congress would never agree to fiscal austerity in the midst of another recession. And Bob is right that Congress needs to understand there are consequences to its continued inaction on the deficit. So, somehow, we need to thread the needle: Make the markets think lawmakers will topple over the cliff without it actually happening.

On the other hand,  the newly elected (or re-elected) president and Congress could show some actual leadership and work for a fiscal agreement everyone knows is necessary—without waiting for the next  crisis. They could. But there is little evidence they will.