'Fiscal cliff' talks: Could they sink US job market?

Warning: That approaching "fiscal cliff" could affect your job, not just your taxes.

President Obama and Congress are negotiating about tax hikes and federal spending cuts that are scheduled to begin in January. Economists say that what the politicians do, or fail to do, has sizable implications for the US job market.

The twin dangers are doing nothing – meaning, going over the fiscal cliff – which could lead to a recession and unemployment rates equal to those of the depths of the Great Recession, or doing too little to address chronic deficits, which could make the unemployment rate linger at a needlessly high levels.

By contrast, a "grand bargain" that softens the blow from the fiscal cliff but also addresses the deficits, is seen by many economists as a solid path forward for job growth.

Of course, gauging the implications of the fiscal cliff for jobs and gross domestic product (GDP) is an art for economists, not a precise science. But forecasters generally agree the stakes are considerable. It's a "rock" and "hard place" dilemma.

On one hand, higher taxes aren't generally good for the economy – especially one where job growth is already fragile. And the full cliff is a lot for the economy to handle: a rise in tax rates to pre-Bush levels in all brackets, more people subject to the Alternative Minimum Tax, and an expiration of a payroll-tax holiday, among other things. On top of that, the scheduled federal spending cuts are large enough to have a potentially adverse effect on job growth all by themselves.

But on the other hand, high public debt isn't good for GDP growth either. And for decades, the US government has often run large deficits – with tax revenue averaging 18 percent of GDP since 1970, while spending has averaged about 20 percent of GDP. In the past few years, the gap between revenue and spending has grown much wider than that average.

How Congress balances these concerns could affect jobs in numerous ways.

For example, letting the tax hikes and spending cuts happen would have its benefits, according to Macroeconomic Advisers, a forecasting firm. The fiscal position of the nation would grow stronger as public debt is stabilized, and that would translate into faster GDP growth starting as early as 2014.

The problem: Even with that faster growth rate, "GDP would be lower and unemployment higher for a decade," compared with a scenario in which Congress prevents a 2013 recession. The Congressional Budget Office has estimated that 3.4 million Americans could lose their jobs if America goes off the cliff, as the higher taxes and spending cuts weigh on consumer demand.

By contrast, merely postponing tough decisions, continuing many of the tax breaks without significantly paring back deficits, would leave the US economy exposed to "serious risk," economists at the banking firm Citigroup argued in a September analysis. Damage to the job market might be averted in the near term, but fast-rising federal debt could result in credit-rating downgrades and weaker economic growth.

"The threat of a decline in investor confidence ... and a full-blown fiscal crisis with serious economic fallout looms over some medium-term horizon," which could mean during this decade, says the Citigroup analysis.

The report lays out three of the possible scenarios or the fiscal cliff and jobs:

• Grand bargain. The best case would be a plan that avoids a cliff-induced recession but also buoys financial markets by reaching an accord for substantial deficit reduction during the next decade. The unemployment rate would fall to 6.2 percent by 2015, driven partly by rising business confidence that the risk of a potential debt crisis has been reduced.
• Over the cliff. If Congress does nothing, the Citigroup economists see a recession, with unemployment reaching 9.6 percent next year. That's not far below the peak unemployment seen in 2009, after the financial crisis. The tax hikes and spending cuts would reduce federal deficits, but unemployment would remain at 8.3 percent in 2015.
• Too timid. Under a deal that falls short of a grand bargain, but which avoids the brunt of the cliff, modest fiscal restraint would be imposed, but not enough to avert the "serious risk" of a fiscal crisis down the road. Unemployment would fall slowly, but only to 7 percent in 2015. It is currently 7.7 percent.