Image: Fiscal cliff © DNY59, Getty Images

We're now just weeks away from the "fiscal cliff" -- an austere package of tax hikes and spending cuts set to kick in Jan. 1, 2013, and worth $720 billion next year alone. Yet the politicos in Washington look miles away from even a short-term extension.

President Barack Obama, charged up by his re-election, opened negotiations by offering a deal (similar to his 2013 budget proposal) that also includes the elimination of congressional authority over the debt ceiling (which will be a big issue early next year). Republicans shifted to a more middle-of-the-road approach originally proposed by former Clinton administration official Erskine Bowles, although he distanced himself from the GOP counteroffer this week. But Republicans still refuse to increase statutory tax rates, preferring instead to increase effective tax rates via deduction limits.

And if there's no deal? Jumping off the cliff would create a mild recession next year, according to the Congressional Budget Office, and push the unemployment rate back over 9%.

But given the smallness of our politics, the best option for the country might be to simply take the leap -- at least temporarily. Here's why.

Cliff diving

What would that mean, exactly?

Falling off the cliff would mean a return to Clinton-era income tax rates, higher investment taxes, deep cuts to the defense budget, the end of extended unemployment benefits and the end of the payroll tax reduction. It would also include other items, such as new taxes on the rich, related to Obamacare. (See "7 pieces of the fiscal cliff.")

Anthony Mirhaydari

Anthony Mirhaydari

In a vacuum, this isn't exactly fiscal Armageddon. And yes, it would help close the near-term deficit. But, given our current vulnerabilities, it would hurt economic growth and therefore have less of a positive impact on the deficit than many believe. This is the type of short-term austerity that Europe has been trying, and the results have been dreadful.

So why do it? It would, I hope, change the dialogue from the current emphasis on small fixes -- trimming spending and imposing new taxes on the rich -- toward a deeper discussion on the root causes of the problem and the real, structural solutions required.

For most people, diving into the deficit debate is less exciting than watching paint dry. And that is why the discussion has devolved into schoolyard smallness focusing on the rich paying their "fair share," the strength of Obama's postelection mandate and which side is going to be bad or good this Christmas.

We got here through a series of similar disagreements and a lot of buck-passing. Failed deficit talks in 2011 led to the congressional supercommittee, which also failed, leaving in place automatic spending cuts. Likewise, we've seen repeated extensions of the Bush tax cuts and other supposedly temporary measures, including payroll tax cuts and extended unemployment benefits.

At this point, I don't know if there is any way to get the American public -- which just can't seem to get its head around the scale of the problem -- to understand what's at stake, other than jumping off the fiscal cliff and getting a taste of Europe's austerity nightmare.

A taste of austerity

Joblessness will rise as the economy tips back into a mild recession. Taxes will go up, mostly on the rich but on everyone else, too, reminding people that giving more money to the Internal Revenue Service should always be a last resort and that the middle class has grown too accustomed to what were to be temporary tax cut measures. And defense spending will be slashed to remind everyone that we can either pay for a strong military or overpay for senior care, but not both.

There are no easy levers left to pull. We need growth. We need lower debt, public and private. We need to reduce the cost of health care and the budgetary burden of Medicare, Medicaid and Social Security to ensure their long-term solvency. And we need to do it now, because if we don't help the economy fast, the problem will just get worse.

Good ideas floating around that have attracted bipartisan support in the past include raising tax revenue in a more growth-neutral way via limiting deductions and write-offs for the wealthy; means-testing entitlement programs like Medicare and Social Security so that benefits are skewed toward the needy; increasing Medicare deductibles so seniors self-limit treatment and consider the cost of care; and increasing retirement ages to account for increased life expectancies.

None of this is easy. But we need a game changer.

A wake-up call

We're in a quandary generations in the making; it can't be boiled down into simple talking points. The electorate just doesn't get it -- with polling suggesting the only solution that garners majority support is taxing the rich. That would help, but it's not enough -- not even close.

(Letting the Bush tax cuts on those making more than $250,000 a year expire will raise around $50 billion to $80 billion a year. Obama is now calling for even more revenue, about $120 billion a year in new taxes. Those numbers pale next to the impact of the fiscal cliff, which Merrill Lynch puts at $720 billion for next year.)

Part of the deficit is a result of a weak economy. Part of it is there because the middle class is still under pressure with joblessness, stagnant wages and negative home equity. Part of it is a consequence of accumulating too much debt because of Bush-era mismanagement, two wars, the 2008 financial crisis and an overreliance on cheap foreign credit from China and Saudi Arabia.

But most of it -- especially the projected deficit over the horizon -- is there because the health care system grew, like a metastasized cancer, into a fat, inefficient resource sink that's not delivering benefits on par with what we're paying. We've decided to postpone the hard choices on what we are prepared to offer seniors who have paid into Medicare and now expect payouts that far exceed their contributions.

Medicare costs are expected to double, to $1 trillion, over the next eight years. Yet according to the Urban Institute, the average couple turning 65 in 2010 had paid $109,000 in Medicare taxes but would receive $343,000 in benefits. And that assumes contributions grew at a 2% real rate of return.

If you take one thing away from this column, burn the image below into your memory. It's taken from Obama's 2013 budget proposal -- which is very similar to his recent fiscal cliff deal proposal.

Publicly held debt under 2013 budget policy extended

Even under unrealistically optimistic economic growth assumptions, and with $150 billion a year in new taxes on the rich, his plan would see both the national debt and deficits continue to grow, due to, as he admits, a lack of meaningful entitlement reforms. (To be fair, there's no Republican plan that keeps debt from rising without gutting non-defense, non-entitlement spending.)

The problem would get much worse if the Fed lost control of inflation or if economic growth turns out to be weaker than Obama expects, which seems likely (he is looking for 3% growth in gross domestic product next year, 3.6% in 2014, 4.1% in 2015, 4% in 2016 and 3.9% in 2017).

Growth now

Moreover, one must consider why current growth is so inadequate. According to new research by the Congressional Budget Office, it's because of a lack of investment in new capital, new hires and new infrastructure. The cash is out there, floating around at nearly zero cost, thanks to the Fed.

But those who have it -- the top 2%, as well as foreign nationals and global corporations -- are scared to do anything with it.

So if we go after these folks with higher income tax rates, higher capital gains taxes and higher payroll tax rates -- in addition to Obamacare-related tax surcharges already about to hit these folks -- do you think that will change?

I know Warren Buffett -- Obama's wingman on these issues -- says those looking to invest don't consider taxation before jumping in, but that's not what economists tell us. It's all about cost of capital and rates of return. And higher taxes raise the cost of capital (especially for small businesses funding expansion and hiring out of retained earnings) while lowering future profits.

It that what we want? Less investment and hiring? The left's economist-turned-deity Lord (John Maynard) Keynes himself wrote that "the weakness of the inducement to invest has been at all times the key to the economic problem."

James Poterba, an economics professor at the Massachusetts Institute of Technology, found that higher capital gains taxes had a "significant influence" on the demand for venture funds. Nobel laureate Robert Lucas estimates that eliminating the capital gains tax and dividend taxes would spur growth and cause America's productive capital stock of plant and equipment to grow large as it is now -- increasing a productive capacity that hasn't really grown since the late 1990s.

The real risk of austerity

We risk repeating the mistakes Europe is making by forcing deep austerity measures -- both spending cuts and tax hikes -- like those now causing so much pain in Greece and Spain. Already, according to the International Monetary Fund, 22% of the current $1.1 trillion annual U.S. budget deficit is the result of a weak economy.

Unless we get the economy revved up again, this austerity-driven madness will end in disaster.

The IMF is screaming as loud as it can that a combination of tax hikes and spending cuts would be even more toxic to the economy, given the environment we're in: ultralow interest rates, indebted households and government, and persistent joblessness.

The time to tackle deficits is when the economy is strong. We didn't. And that isn't Obama's fault.

Yet attacking the rich, especially if the motivation is social fairness or outright retribution for perceived grievances (let's get those fat-cat bankers), will prove to be a tragic example of cutting off your nose to spite your face. We need to solve the root causes of the problem -- or else we're destined to a future of economic stagnation, more joblessness, less investment, higher inflation (as the Fed tries to compensate for poor fiscal policy with more monetary policy stimulus), more structural inefficiencies, higher taxes and persistent deficits.

Don't get me wrong: I am well aware that the economy has grown more unequal, and I have written frequently about it.

Over the past 30 years, the share of the economy held by labor -- working families -- has fallen due to a combination of factors. Some of these were self-inflicted, as people filled their homes with cheap Chinese imports, trading jobs for HDTVs. Some of this was related to Beijing's currency manipulation and unfair trade practices. And some was caused by a stall in U.S. labor productivity as capital investment cooled.

But austerity isn't the way to solve this. Yes, the rich have a role to play in "resetting" this morass. And I'll discuss two ways they can do that next week. So stay tuned.

Shock treatment

The threat of going off the fiscal cliff, as scary as it will be for many people, might be the slap in the face America needs to start thinking more broadly after years of fiscal cowardice. And this short, lame-duck session of Congress is a good time for big action.

Yes, thinking big means ignoring the shrill voices of rigidity -- whether it's the AARP protecting entitlements or Grover Norquist defending his anti-tax pledge. It means no more demagoguery. And it means ignoring the sirens' call to concentrate on merely soaking the rich.

For investors, things could break either way. We could go over the cliff, and stocks could follow. Or Obama and the Republicans could hammer out a short-term deal and agree to tackle entitlement reform in the New Year -- a positive outcome that would surprise pretty much everybody and send stocks screaming higher.

For now, after showing renewed optimism in November, investors seem to be pulling back. Option protection is rising in popularity on a scale not seen since the September market top as people try to insulate their portfolios from the uncertainty. And key market issues, including Goldman Sachs (GS) and Deere (DE), are looking very weak.

But the bears are constrained by next week's December Federal Reserve meeting, where the central bank is likely to announce a fourth round of quantitative easing.

If that isn't enough to make you expect a jumpy, volatile market heading into the end of the year, consider this: After the cliff comes the debt ceiling -- which we could hit as soon as February. If Washington gives us another go-round over that, we could face a repeat of the market chaos of August 2011 and the debt downgrade that resulted. 

Let's hope Washington faces up to the hard choices before that.

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At the time of publication, Anthony Mirhaydari did not own or control shares of any company mentioned in this column in his personal portfolio. He has recommended shorting Goldman Sachs to his clients.

Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.