GOLDMAN: The Middle Class Won't Do Too Bad If We Go Off The Fiscal Cliff

family 1970s middle class

Photo: ericdege on flickr

The “fiscal cliff” looms in the United States as lawmakers face the possibility of automatic tax increases and spending cuts at the beginning of next year unless a deal can be reached to avert them.The economic effects of “going over” the “fiscal cliff” would be pretty severe, according to most analysts – JPMorgan, for example, estimates such a scenario would knock 3.5 per cent off GDP growth in the first quarter of next year alone.

Now, it’s become the biggest worry among fund managers, according to a recent BofA survey.

Goldman Sachs economist Alec Phillips has an interesting perspective on the effects of the cliff, though, in a note to clients today: he writes of the adverse scenario of going over the cliff that “the effect on the lowest and highest income groups is likely to be greater than the effect on groups in the middle.”

The thesis is pretty clear based on the chart below showing Goldman’s calculations of the effects of various spending cuts and tax increases across income groups.

The middle income brackets, according to Goldman, won’t see as large of a drop in incomes as those in the lowest and highest brackets:

Fiscal cliff income effects

Photo: Goldman Sachs

Here is Phillips’ reasoning:

The other two policy changes we assume in our base case–the phase down of unemployment benefits and the implementation of the ACA taxes–would affect only the very low end and the very high end of the income spectrum, respectively. Because the EUC program provides benefits to workers who have been jobless for 26 weeks or more, at an average payment of around $300 per week, this puts most recipients in the lowest income quintile.

A complete expiration of the program–this would occur if Congress did not intervene in the fiscal cliff before year end–would result in a sharp drop in average income in this group. Our base case assumption is that benefits continue to phase down in 2013, resulting in a reduction in disposable income in the lowest income quintile of around 2%, or about one third the effect of full expiration. ACA taxes–the 0.9% tax on earnings over $250,000 and the 3.8% tax on passive income over that level–fall not surprisingly on the very top of the income spectrum.

There are other effects that Phillips expects will impact all income groups – for example, he writes that “the payroll tax cut has similar effects on disposable income across income levels, at least until the 90th income percentile.”

By those measures, maybe Congress should just vote to extend emergency unemployment compensation and call it a day.

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