Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

The end of the 2012 fiscal cliff drama was largely predictable. Faced with the prospect of large and immediate tax increases, Congress acted to raise income tax rates only on relatively well-off people — and also to allow payroll taxes to increase for all working Americans. The messy compromise raises revenue, although it does not bring our medium-term deficits under control, and it is unlikely to push the economy back into recession.

Today’s Economist

Perspectives from expert contributors.

Unfortunately, the legislation that passed the Senate late on New Year’s Eve and the House on Jan. 1 sets up another fiscal-cliff-type experience – with a fight over extending the debt ceiling looming in about two months. And the outcome then could well be a significant slowdown in the economy and a struggle that might end up in front of the United States Supreme Court.

About the end of February, the Treasury Department will have exhausted its legal authority to borrow. Congressional authorization will be needed to allow additional federal government debt to be issued; this is the debt ceiling.

The last time the United States came close to hitting the debt ceiling, in summer 2011, a game of chicken was played on Capitol Hill and with the White House – with many Congressional Republicans insisting that the debt ceiling would not be extended unless there were matching spending cuts.

This led to the Budget Control Act of 2011, which created the now-infamous sequester mechanism: if politicians could not agree on ways to limit spending (and raise taxes), automatic spending cuts would kick in for both domestic and military programs of the government.

Under the New Year’s Day legislation, this sequester was postponed until the end of February.

So the next fiscal cliff includes both hitting the debt ceiling and carrying out the sequester. By itself, the sequester will cause government spending to fall in an arbitrary and inefficient manner. This will slow the economy to some extent.

But the greater danger is that world markets will be plunged into chaos when the debt ceiling is not extended, because this creates the prospect that the United States government will be unable to make payments on its existing obligations unless it breaks the law or makes vast spending cuts.

Using the debt ceiling in budget negotiations is a dangerous and irresponsible tactic. In summer 2011, financial markets were severely strained by the prospect that the United States would not pay its debts. This pushed up yields on risky debt around the world (including in Europe) and caused the stock market to fall almost everywhere.

Yet House Republicans seem willing to play the same card again unless they get large cuts to domestic discretionary spending by the federal government (or perhaps big cuts to Medicare, which is part of what they were asking for in 2012). The Obama administration and most Democrats will refuse to agree. Another showdown will loom.

In think about likely scenarios, you need to assess what the Supreme Court might do if it were to take center stage on the debt ceiling.

While the Tea Party movement is greatly weakened, it may still be strong enough to block any extension of the debt ceiling. If that were the case, an impasse with a great deal of impassioned rhetoric would result.

At the end of the day, the administration would probably break the debt ceiling and take its case to the Supreme Court. While the court’s ruling on the constitutionality of the Affordable Care Act was a significant moment in summer 2012, any decision on the debt ceiling would be much more important. We haven’t seen a court decision with that kind of potential macroeconomic impact since the 1930s (when the legality of suspending the gold standard was reviewed).

Many legal arguments will be heard, and in the end the Court is likely to be swayed by an assessment of the potential implications. If the government has already broken the debt ceiling, determining that this is unconstitutional would cause chaos for the United States and the global economy. As in the 1930s, the court would not want to second-guess the macroeconomic decisions of the administration, I hope.

Whatever the Supreme Court outcome, going down that route would create a great deal of uncertainty – and is likely to affect some investment and consumption decisions and to slow the economy enough to create a new recession.

For a specific quantitative measure and a great deal of helpful thinking on this issue, I recommend the work of Nicholas Bloom of Stanford University (with Scott R. Baker of Stanford and Steven J. Davis of the University of Chicago) on their general Web site and in their most recent paper, updated this week.

Their Economic Policy Uncertainty Index shows a big spike on the debt ceiling dispute in August 2011. We will face a comparable or even larger effect in early 2013. So the question for our politicians will be: whom do they think will be blamed for creating such an uncertainty-induced recession?

Based on its experience in 2012, the Obama administration will feel that it does well by standing up to the Republicans on fiscal issues (although some Democrats, of course, wanted to take an even stronger line). I do not see the two sides coming together on spending issues, so I expect a version of the sequester.

The Republicans are obviously divided on fiscal policy and many other issues; one is how extreme they want to be perceived to be relative to mainstream opinion.

Most likely the Tea Party faction will dig in deeply, as it did on Jan. 1, when the fiscal legislation passed the House with support from most Democrats and enough Republicans who were willing to vote with the administration (and the Senate). This is, of course, a sharp contrast to what happened at the start of President Obama’s first term, when all the House Republicans, without exception, voted against the fiscal stimulus package.

The Republicans will split, but more of them are likely to side with the Tea Party movement than was the case this week. We are headed directly for another fiscal-cliff confrontation – and this one could be much more damaging.

Article source: http://economix.blogs.nytimes.com/2013/01/03/the-supreme-court-and-the-next-fiscal-cliff/?partner=rss&emc=rss