In early January 2013, a lot of tax cuts expire.
The Bush tax cuts, extended a couple of years ago, end. That will raise taxes on the wealthy and the middle class.
Other tax rebates and the child care tax credit expire. This will raise taxes on percentiles 20 to about 45.
This will suck money out of the economy, true, but even worse will put tax planning in the toilet. The result is a giant case of uncertainty. If you don't know what your net income is going to be next month, that affects your spending. 200 million Americans, many business owners and managers, are just like you. That means fewer new hires, and it means less investment in business. That means more people getting government assistance and fewer paying taxes.
Government spending will be cut, but not on a case-by-case basis. Well, maybe. Nobody knows. The cuts don't have to be across the board on every program, just down to a certain level of budget "granularity." Obama could spare some programs and make deeper cuts to others. Nobody knows what he'll do because when asked he didn't answer. Answering would have made the game of chicken both sides are playing less high-stakes and worrying. He still hasn't, as far as I know. That means a lot of government workers don't know if they'll be laid off. A lot of people receiving money don't know if they'll get money. And since a lot of those "people" are contractors with employees, none of those employees know what's up.
But you also have to look at investors. They're affected a dozen ways by this, and one way is by the availability of a lot of government debt. If the budget deficit is suddenly reduced there may not be enough debt to soak up all the investor money. They won't put it into their businesses because of all the uncertainty. It'll just sit there as a consequence, unlent and unused. Since one reason the dollar's as strong as it is, we may see the dollar weaken even as there's more fiscal integrity; at the same time, the fiscal integrity is due to weakness and ill-will, hardly a harbinger of a time of prosperity and good feelings.
Now, one thing important in the economy is the "velocity of money," how fast a dollar changes hands. It's ultimately responsible for the Keynesian multiplier. If all that money is just sitting there, then the velocity of money will decrease--which is equivalent to shrinking the money supply. But lending money is also a way of increasing the money supply, and with less debt being issued we'd probably need the Fed to step in with a new bout of "quantitative easing," but easing that nobody would take advantage of.
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