The Fiscal Stiff
US Vice President Biden
and Senate Minority leader McConnell brokered an agreement that was approved by
the Senate that seems to avoid the full fiscal cliff. It now is before
the House of Representatives.
While the Jan 1 deadline
is passed, the more significant one, we had argued was Jan 3, when a new
Congress is sworn in. A failure by the 112th Congress to finalize the
legislation would mean that process would have to begin anew with the 113th
After what is likely to
be intense though short debate, the House of Representatives can either approve
the same exact bill the Senate approved, which be the quickest resolution.
It can seek to amend the bill, in which case it must return to the Senate
for their approval. The process could be cumbersome and require
reconciliation and would risk the Jan 3 deadline. Alternatively, a
majority of the House could fail to ratify the Senate bill, in which case, it
will be up the next Congress to claw back from the other side of the cliff.
This sketches the procedural
course in the coming days; let's turn to the substance of the Senate deal.
The key highlights include, a 4.6 percentage point increase (to 39.6%)
the marginal tax rate on those households earning more than $450k ($400k for
individuals), tax deductions. Although credits begin phasing out on $250k
incomes, the dividend and capital gains tax will only be hiked to 20% (from
15%) on households earning $450k ($400k for individuals). The
payrolls saving tax, which had been reduced by 2 percentage points during the
financial crisis, will be restored to 6.2%, which will impact all private sector
employees. There was full year extension in unemployment compensation.
The Alternative Minimum Tax was permanently indexed for inflation.
It delays a 27% cut in payments to Medicare providers for a year.
One of the reason why
this agreement is not a slam dunk in the House of Representatives, once over
the hump of tax increases, is that there are no spending cuts. Instead
the Senate agreed to delay for two-months the $110 bln in the automatic
spending cuts that were part of the fiscal cliff. Even the $30 bln for
the extension of the unemployment benefits has not been offset with spending
cuts. The idea being that after a cooling off period, fresh negotiations
will be required to secure spending cuts.
On the other hand, one
of the reasons that the Republicans can approve the bill is that they may still
have a trump card: the deb ceiling. The federal government reached
the debt ceiling at the start of the week, which limits the government's
ability to borrow. The US Treasury has begun taking "extraordinary
measures" to minimize the immediate impact. These maneuverings are
not limitless, but a several weeks. It appears that an increase in the
debt ceiling is needed by late February or early March, though creativity of properly
incentivized politicians and bureaucrats should not be under-estimated.
We have outlined the
procedural process, the substance and limits of the agreement, now let's
briefly sketch out an evaluation.
1. The capital
markets have seemed to have generally looked past the self-inflicted fiscal
cliff debate in the US. As we have noted, fiscal consolidation was not
being forced on the US via a capital strike the way it was in the periphery of
Europe. It was more a political problem than an economic problem. Yet, until
the House of Representatives play their hand, there may be not big market
reaction. This is also consistent with the thinner market conditions.
The economic data in the coming days features the monthly PMI readings
and US auto sales and employment report (at the end of the week).
2. The economic
slowdown that the US appears to have experienced in Q4, which appears to be
about half of the 3.1% pace seen in Q3, seems more a product of inventory draw
down, rather than the uncertainty of the fiscal cliff. Core durable goods
orders rose at a healthy clip in Oct and Nov and private sector job growth did
not slow. Without going fully off the cliff, we continue to expect the
US economy to be among the strongest in the G7 in 2013 with a little more than
2% growth. The ECB and EC have have successfully reduced some of the
extreme tail risk in Europe. China's economy has begun strengthening.
These three issues had been among the chief concerns for investors.
3. We had thought
investors would have sense of closure on US fiscal policy early in the new
year. Now it does not seem likely until late Q1. In a larger sense
many structural issues that are needed to ensure the US is on sounder fiscal
footing, while at the same time, addressing the weakness in its physical
infrastructure and ensuring people have skills necessary to participate in
competitive marketplace, have not been addressed.
4. Many Republicans will
not be happy with the agreement, but Obama had all the cards. The
Democrats have the executive branch and a majority in the Senate. While
the Republicans enjoy a majority in the House of Representatives, Democrat
candidates as a whole actually received more votes. Moreover the
Republicans are split as the failure of Boehner's Plan B illustrated.
Ironically, the split is very much like in the German Greens. There
is a realos faction that wants to govern. There is a fundos faction that
puts principle ahead.
5. The real
question is why didn't Obama push his full advantage? The answer, as we
have implied before, on economic policy Obama is not very different than some
Republicans. Others, like Bruce Bartlett, an official in the Reagan and
Bush I governments, recognizes this in a piece in the Fiscal Times " How Democrats became Liberal
Republicans". None less than Obama himself recognizes
this. He explained recently to an Hispanic audience that he was not a socialist
as some of his critics assert, but rather his economic policies, would have
made him a moderate Republican in the 1980s.
6. One of the
great unspoken truths during a debate that seemed to speak a lot of untruths is
that the raising of the taxes on the wealthy (however defined) is not
sufficient to close a $1 trillion deficit or reduce the America's debt.
The driving value was not fiscal correctness, but a sense of fairness.
The concentration of wealth and income in the US increased during the
credit crisis (and some like ourselves and others, like Jim Livingston at Rutgers, see it as a
critical cause of the crisis) and is increasing in the
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