Lately, the US has been winning the investment beauty contest among Cinderella’s ugly sisters. Europe’s addiction to austerity, rolling rescues, and inability to address internal imbalances means at best a wild ride and at worst a crisis resurgence. China still has its perennial fans, but long-standing bears like Jim Chanos have been joined more recently by Marc Faber, who foresees 3% growth, which is tantamount to a recession. Japan is struggling with a mile high currency. The US, by comparison, does not look too bad.
Or does it? One of the lurking worries in the background is the so-called fiscal cliff. At the end of 2012, a whole passel of tax breaks and special programs expire, from lower payroll tax rates to extended unemployment benefits. This has been lurking in the background for a while (indeed, the US would have faced a contraction in fiscal spending at the end of 2012 had various breaks not been extended).
Ben Bernanke brought the issue to the fore in Congressional testimony today, stating that consumer spending would suffer if Washington continues on an inertial course. Estimates of impact vary considerably. Normura puts the effect at nearly 5% of GDP in the first half of fiscal 2013, which starts October 2012. Deutsche Bank estimates the drag at only 1% of GDP, but the consensus seems to be 3% to 5%.
Needless to say, Wall Street does not want its punchbowl taken away (they really don’t care about the impact on ordinary people) and Uncle Ben also said clearly that he can’t compensate for the contractionary impact, so we have a flurry of alarmed reports tonight. (Mind you, I’m not saying this isn’t a big deal, but what it takes to precipitate coverage is amusing).
Some recent commentators are worried that it isn’t possible to get a deal done post election (the trigger date for most of the changes is calendar year end). For instance, FT Alphaville pointed to this column by Stan Collander a few days ago:
Even if there were an agreement on what that should include — and there absolutely isn’t — it would take longer than four to seven weeks just to draft the basic legislation, let alone debate and pass it in committee, debate and pass it in the full House and Senate, come up with a compromise agreement between the two chambers, redraft the compromise and pass the conference report. Add in the need for transition rules, which took a year to draft when the 1986 tax act was adopted, and it’s ludicrous to think that tax reform has any chance of going anywhere during the lame duck.
Keep in mind this is the wrong frame. The issue is whether Congress will decide to renew EXISTING initiatives, not fundamental tax overhaul (in fairness, Collander predicts that stopgap measures are all that will result). Tax maven Lee Shepperd points out that a surprisingly large portion of the tax code is renewed every year, and she is sanguine about the fiscal cliff turning out to be a non-issue.
But as we so far away from business in usual in DC that all bets are off? The Republicans are keen to cut the deficit, or at least like to pretend to be, and if the economy is more or less where it is now or a smidge better, they’ll certainly be champing at the bit to drop the extended unemployment benefits. The Dems would posture that they’d want different breaks eliminated, such as ones like the Bush tax cuts that would hit the well off more. Normally, the expected resolution would be simply to extend the whole shebang, since neither side would give up its half a loaf. But this is a Congress already beset by intransigence, and lame-duck sessions aren’t great for rallying the troops. And on top of that, the budget ceiling will come into play, which will further complicate agreeing on stopgaps.
The lack of focus on the issue in Congress is not a good sign. As Sebastian Mallaby writes in the Financial Times:
….the omens are bleak. Rather than seek a mandate to eliminate tax loopholes and discipline health spending, which are the two central components of any intelligent budget fix, candidates on both sides resort to sound bites
The better way to frame this might be: will all the talk of grand bargains get in the way of some fixes to keep the US from unwittingly going the austerian route? I’d hazard it is too early to tell. While Congress can often squeak legislation through just before deadlines, the ascendancy of the deficit hawks may mean the non-fix is in.