Impact of the “Fiscal Cliff” on Arizona

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If the federal government steps over the “fiscal cliff” will it take Arizona with it? ASU Economist Dennis Hoffman talks about the local impact of federal spending cuts and tax increases set to take effect in January unless Congress intervenes.

Ted Simons: Good evening and welcome to "Arizona horizon." I'm Ted Simons. The election may be over but the so-called fiscal cliff is still alive and unresolved. The fiscal cliff is a move to reduce the federal deficit by way of tax hikes and budget cuts that are set to take place automatically at the end of the year. Many economists think that the combination of higher taxes and reduced spending would send the country into another recession. The only way out is for lawmakers to come up with a deficit reduction plan. But that is proving difficult to say the least. Here to talk about the impact of the fiscal cliff on Arizona is ASU economist Dennis Hoffman. Good to see you again. Thanks for joining us. That's pretty much what the fiscal cliff is.

Dennis Hoffman: Indeed. You summarized it very well, Ted.

Ted Simons: It hits at end of the year. What kind impact to Arizona here?

Dennis Hoffman: Well, let's just do the arithmetic of the cliff and not speculate about what elements are more likely than others. It's a big deal. It's $700 billion nationally, on that order, $700 billion nationally. Some of the aspects that are definitely going to hit Arizona in the arithmetic would be, you know, the holiday on social security taxation expiration. That's a 2% hit, a 2% increase in taxes. So you will see your incomes fall 2% by paycheck starting January 1. And frankly there's not a lot of talk in D.C. about extending that tax holiday another year. But who knows what comes out of the sausage machine as they say. But that's definite. That will be felt by all Arizonans. There's important defense reductions as part of sequestration plan. And those would be defense cuts that are on the docket. you know, some people have said a 10% across the board. Reduction in defense spending. it's kind of hard to believe that they would do it that way. so the question then would remain, are the operations in southern Arizona either with the bases or with, say, a Raytheon missile systems, are the operations in east mesa, are they at risk? And I'm not saying that they are. But, hey, if defense cuts are on the table, then, if I'm a producer in the defense industry, and Arizona is pretty high, if you look at procurement by the department of defense across the states. We're a serious cob tender for defense dollars.

Ted Simons: Aerospace, drone technology which is very big in Arizona. That all has to be factored in.

Dennis Hoffman: Sure. Some of the more cutting edge drone and some of the security and surveillance areas, you know, one might speculate those would be retained. Again, it causes uncertainty. And I think uncertainty is really the name of the game here. That's what you see with Wall Street. Wall Street hates uncertainty. And that's what this cliff debate has created.

Ted Simons: As far as Arizona, talk about direct impact. What about indirect impact, induced action? You can talk about the x's and the y's but there's another alphabet deep down below you have to consider as well.

Dennis Hoffman: Indeed. And induced effects are interesting in the economy. And you can explain these in a number of different ways. I remember stories about the great depression. And I will get to Arizona very quickly but I remember stories about the great depression, and merchants in Manhattan not worrying about almost laughing at the plight of these financiers in 1929, when the stock market crash hit. Thinking that they were somehow immune to the debacle that was taking place. In a couple of years those merchants had very, very tough times. so if you are, you know, if you are in Tucson or east mesa, what do I care about military procurement? I run an auto dealership or I run a clothing store. I run a restaurant. Well, those businesses are local. They exist because of the injection of these external dollars. And a lot of our external injections come from the department of defense. So everybody will feel it.

Ted Simons: Would Arizona get hit harder than other states?

Dennis Hoffman: I think that our reliance on defense would make us exposed at a greater level than some other states. Now, there are some states that are even more reliant, some cities that are even more reliant on the defense expenditure than cities in Arizona. but Tucson is certainly one of the ones, if you look at, say, a sequestration risk, that would be very high and that's because of the importance, the military has in the relatively small economy of the metro Tucson area.

Ted Simons: In f-a general recession were to hit -- and again this is the worst case scenario. if the fiscal cliff occurs and nothing changes, there could be incremental changes here. There could be tax hikes not quite as high, maybe higher income levels, budget cuts, maybe not quite as much. The possibility there kind of makes the equation a little scrambled.

Dennis Hoffman: Ok. I think that's a very, very good point. It's likely, no matter what comes out of this sausage machine, it's likely to be in phases, if there are phased-in cuts or phased-in tax hikes that take place. The one that would be most likely immediate would be that 2% increase in taxes, payroll taxes as the holiday is eliminated. That would be the one that would be the most immediate. But all in all, it's about a $700 billion shock to the economy negatively. Now, interestingly, ted, that is about the same order of magnitude as the recovery act spend that was phased in during the Obama administration in the first term.

Ted Simons: Interesting.

Dennis Hoffman: And there's certainly a number of economists that said that didn't matter, that didn't do anything. And it would be interesting to know whether or not those same economists are thinking about that. Much of that, by the way, much of that $700 billion came in the form of tax cuts. So most of this $700 billion is coming in the form of tax increases.

Ted Simons: Is Arizona, if a recession were to occur, the impact on Arizona's economy in state business, in state commerce, just the general well-being of instate residents?

Dennis Hoffman: Ted, what I am seeing and I'm seeing -- I don't know if the event was Lehman in the fall of 2008 but it was sometime mid-2008, early 2009, I became a big believer in the impact of psychology, the so-called behavioral side of consumer attitudes. And what this economy I don't think I can afford and certainly what the Arizona economy cannot afford is a shock to consumer confidence, a negative shock to consumer confidence. Just when we are finding some footing, equity prices have found some footing and they are still quite high. Housing prices are finding footing. There are signs of life in the housing market. The pace of retail sales has been pretty strong over the last year, especially consumer durables. All those signs point to a consumer that's becoming more and more confident. But if Washington, D.C. again illustrates to us that they are completely and totally dysfunctional, unable to come to any agreement, or any terms on this, then, I fear that it would rattle confidence. And then the question is how much is it rattled? And what are the residual effects?

Ted Simons: And how do you adjust? How do you get back to unrattled status?

Dennis Hoffman: Exactly.

Ted Simons: Compare going over the cliff to what seems to be a major sticking point and that is a tax hike on those who earned income, $250,000 or more. What is a bigger jolt to the economy?

Dennis Hoffman: Well, economists are going to debate this and I think ideology, you know, would enter into some of these debates. Economists talk a lot about the impact of on incentives and marginal tax rates at high income levels. I think that's important. That's an important discussion. There are times in our history when we reduced marginal tax rates in 1960, they were 90%. We reduced them to 70. When Mr. Reagan took office, they were 70%. And by the time, at one point in his tenure, they were down to 28%. So right now they are 35%. We are talking about elimination of the bush tax cuts, would add 4.6% on that top rate. That will be important, would have a dampening effect on the economy but nowhere near the kind of dampening effect that would take place if we were to, you know, as we have historically, jumped those rates up to 40, to 50, to 60, to 70%. And that is not in the cards.

Ted Simons: One last thing, there's talk of the U.S. credit rating dropping as well.

Dennis Hoffman: Yes.

Ted Simons: That factors into the equation.

Dennis Hoffman: Absolutely. so if this cliff opportunity can pave the way toward the more grand bargain scenario that we have talked about here a bit before, a step towards Simpson-Bolles and that may not be the right solution but if we can deal with the long run entitlement issue and indeed the entitlement challenge is, ted, you and I haven't paid enough in to Medicare to pay for the benefits we are going to get out of Medicare. We are not alone. Our generation hasn't. The prior generation hasn't. And there's really no plan for the next generation to do so either. We have got to get some resolution, some balance and some sanity into dealing with our entitlement challenge.

Ted Simons: Make that will be forged out of this particular crisis. Good to have you here. Good information and good to see you again. Thanks for joining us.

Dennis Hoffman: Great to be here, Ted.

Ted Simons: What is the future of school funding in Arizona? It's a question that many educators are asking after the defeat of prop 204, which would have made permanent a temporary 1 cent sales tax hike, with most of the revenue going to education. Government and some lawmakers acknowledge that education has taken big cuts in recent years, and reported to be looking at increased funding plans. here to talk about all this is Timothy Ogle, Executive Director of the Arizona School Boards Association, Chuck Essigs, Director of Governmental Relations for the Arizona Association of School Business Officials, and John Arnold, Director of the Governor's Office of Strategic Planning and Budgeting. Good to have you all here.

All: Thanks for having us

Dennis Hoffman:ASU Economist;

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