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Emerging 'Fiscal Cliff' Deal Could Push Economy Into Recession

NEW YORK ( TheStreet) -- Washington has always made lots of things -- bureaucratic regulations and hot air to name two -- and it even prints money that instigates inflation. Now in the names of fairness and fiscal responsibility, President Obama and House Speaker John Boehner are cooking up a deal to avert the fiscal cliff that could easily thrust the economy into a deep recession.

Taxes are going up.

Just about everyone agrees the two-percentage-point temporary reduction in the payroll taxes will lapse -- it is too much of a drain on the solvency of Social Security. That will raise about $125 billion in revenue for 2013.

It is now apparent the Bush-era income tax reductions for many wealthy families will not be extended. Obama is now willing to settle for raising rates on families earning over $400,000, whereas Mr. Boehner wants to set the threshold at $1 million. The cutoff that will likely emerge is about $500,000 and would generate another $50 billion a year in income taxes.

The administration would also like to limit the value of itemized deductions and other tax breaks, including the tax-free status of municipal bonds. Boehner is inclined to go along and if he accepts the president's framework, it should generate another $50 billion in income taxes.

Republicans want spending cuts that at least match tax increases. The question is what tax increases will they get matched -- $100 billion in additional income taxes or that sum plus the additional $125 billion obtained by letting the payroll tax holiday lapse.

Given how stubbornly the president defends the rapid growth in entitlements and his desire to extend long-term unemployment benefits, the likely target for Republicans is $100 billion in cuts from permanent reductions in entitlements and some trimming in other domestic areas and defense.

The president also wants some jobs creating temporary infrastructure spending in the range of $50 billion but that will take at least years to actually be effected.

Hence, overall taxes will rise about $225 billion and spending will be cut by about $75 billion, subtracting at least $300 billion from GDP in 2013 -- or nearly 2%. Owing to the ripple effects through the economy, that will mean about $450 billion from GDP in 2014.

The economy was growing at 2% until nervousness about the "fiscal cliff" recently dampened business spending and hiring.

Though some economists were optimistic that the housing recovery and stronger auto sales could spell better times, with such a new large drag on the economy, GDP growth in 2013 and 2014 will likely be below 2% for the next several quarters.

At that pace, businesses can easily handle most new demand by increasing productivity, and even trim payrolls to further boost profits. Hence, growth below 2% for several quarters could easily instigate a negative feedback cycle -- layoffs cut household income and consumer spending, and in turn, the latter begets more layoffs.