If you think that the last-minute deal to avoid going over what came to be called the fiscal cliff solves anything, think again. Yes, it is a compromise, but a compromise that merely kicks the famous can down the road for 60 days.
And a compromise reached only after the December 31 deadline but, mercifully, before the markets opened on January 2, demonstrating once again that the political class is congenitally incapable of timely governing. By comparison, decision-making in Brussels looks a model of efficiency, and coalition government in Westminster looks like a harmonious gathering of serious policymakers.
Here is what is left unresolved, to be confronted in March:
- The Treasury, which on December 31 hit the legal limit on what the US can borrow, will run out of accounting tricks, and be unable to continue borrowing $40 for every $100 it spends. Republicans and the president are at odds over how to solve this problem and an impasse threatens. But default does not: ongoing tax receipts will cover interest payments on the debt 10 times over. Inability to borrow would force, not a default, but a cut in government spending.
- The cliff deal’s two-month postponement of $110bn in automatic spending cuts over nine years expires.
- The measure funding government agencies lapses. Unless there is some agreement for ongoing funding, the government will shut down—no guides in the national parks, no staff to issue passports or visas, no disease control.
The battle lines are clearly drawn. Republicans are insisting that any solution to these problems must include significant reductions in future spending on healthcare, pension and other entitlement programmes.
The president wants these problems solved by again raising taxes on “millionaires” and companies. He apparently does not hear any pips squeaking after last week’s increases in the rates families earning more than $450,000 pay on their income, capital gains, dividends and estates, and in payroll taxes paid by everyone. Some liberals cite the fact that marginal income tax rates exceeded 90% between 1944 and 1963, while the nation generally prospered. And that the portion of GDP claimed by the government remains about 10 percentage points below that of steadily prosperous Germany.
As Lindsey Graham, a well-respected Republican senator, put it on New Year’s Day: “Round two’s coming, and we’re going to have one hell of a contest about the direction and the vision of this country.” The White House puts it slightly differently: “We are headed for 60 days of nastiness.”
Many insiders here believe that all of these issues will be rolled into one negotiation, resulting in a “grand bargain” that finally sets fiscal policy on a sensible course. Democrats would agree to cuts in entitlements, and Republicans would consent to the increase in the tax burden on the wealthy that would result from reductions in deductibility of such expenses as mortgage interest and charitable contributions.
In my view that is highly unlikely. Democrats are sulking after being pressured by Vice-President Joe Biden to concede that the new higher tax rate be applied only to families earning more than $450,000, rather than $250,000. They resisted even a slight reduction in the burden of entitlements, rejecting extending the age at which benefits begin to flow, and refusing to go along with the president’s proposal to replace the flawed cost of living escalator used to determine pensions with a sounder one that results in a slower escalation.
Republicans, meanwhile, feel they have been forced to accept a deal that is all tax increases and no spending cuts. Indeed, a majority of Republicans in the House voted against last week’s deal and many face re-election battles in Tea Party territory. I very much doubt that we will see peace in our time—unless the political landscape changes sharply when a new president is elected in 2016, a process that is already being discussed in Washington watering holes.
When Biden brokered the recent deal, several media outlets, having in mind Hillary Clinton’s health problem, called December 31 “the first day of the Biden presidency:” his would surely be a tax-and-spend administration.
Nor is there any reason to believe that a candidate favouring compromise will emerge from the Republican primary circus. The central tenet of the Tea Party is “no new taxes” and party activists are already targeting Republicans who voted “yes” on the cliff deal.
The long-run question is not whether sanity will return to American politics, but whether the private sector can overcome the headwinds created by the political battles that reflect real ideological divisions among American voters. This leaves economists with the unenviable job of guessing the economy’s path in 2013 and beyond in the presence of the uncertainty this fraught political environment creates. Most have decided that, at least in the near term, the economy will bumble along, growing at between 0.5% and 2%. That broad consensus just might be a bit on the dark side.
The private sector continues to create jobs—almost 2m in 2012. Stock markets are signalling better times. Growth in the important service sector is accelerating. The earnings of America’s largest companies (those included in the S&P 500 index) are expected to rise by at least 5% and as much as 10% this year. The recovery of the housing sector continues to accelerate. Auto companies seem set to shift more than 15m cars and small trucks, topping 2012 sales of about 14m vehicles. The development of shale gas resources and the attendant growth of manufacturing industries dependent on that low-cost fuel is another bright spot.
Throw in loose monetary policy that is driving the dollar down and exports up, and loose fiscal policy—annual deficits of $1 trillion—and the economy might surprise on the upside after the March battles are behind us.