The Fiscal Cliff

From the BBC:

"Q&A: The US fiscal cliff"

The US faces a deadline to agree new legislation that could make or break the global economic recovery. The so-called "fiscal cliff" has been on the horizon for two years, but now the 31 December deadline is almost here. President Barack Obama has cut short his Christmas holiday in Hawaii to return to Washington DC for yet more meetings to try to work out a solution. Negotiations are expected to continue right up to, or even slightly beyond, the end of the year.

Why are we here?

President Obama's administration has been at loggerheads with Congress over the level of government spending and tax rates. Congress refused to raise the US government's borrowing limit - the "debt ceiling" - which is set by statute. But other legislation passed by Congress commits the federal government to spending and defines its ability to raise tax revenues, which threatens to push it through the statutory borrowing limit. In a bid to break the stalemate, both sides agreed in August 2011 to set up a bi-partisan committee to find ways of capping US government spending over 10 years, plus find another $1.2tn (£758bn) in savings over the period.  The committee set its own ticking timebomb. Fail to reach a deal by 31 December, and automatic spending cuts and tax rises would be triggered. The committee failed.

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What is the fiscal cliff?

On 31 December, a raft of temporary tax cuts is due to expire, just as huge automatic spending cuts are introduced.  This is the fiscal cliff that the US is staring over. Individuals and companies will be hit simultaneously with tax rises and reductions in government contracts, benefits and support. Some $607bn of cuts and tax rises are planned, including reductions in the defence budget, the end of an employee tax holiday, changes to Medicare allowances and higher personal taxes. The lower-paid will lose some child and income credits, while the long-term unemployed will lose their right to continue drawing benefits.  The political intention behind the cliff is that both sides have too much to lose: Republicans are loath to allow the Bush-era tax cuts for high income earners to expire or defence spending be slashed; Democrats want to maintain President Obama's temporary measure to help the unemployed and low income earners, and to avoid deep cuts in non-defence spending. To complicate matters further, the Treasury Secretary Timothy Geithner has warned that the government is running perilously close to its legal borrowing limit once again, although he has bought it an extra two months until the end of February through some accounting tricks.

Why does it matter?

Analysts have painted a grim picture of the consequences for the world's largest economy, with some warning that the impact could push the long-running eurozone debt crisis into the shade.  "The US fiscal cliff represents the single biggest near-term threat to a global economic recovery," the Fitch ratings agency said recently. "The dramatic fiscal tightening implied by the fiscal cliff could tip the US and possibly the global economy into recession.  "At the very least it would be likely to halve the rate of global growth in 2013." The IMF has warned that even the uncertainty raised by the fiscal cliff has hit global investment and job creation. If the US actually fell off the cliff it could knock possibly four percentage points of growth off the US and undermine the fragile confidence in the rest of the world, it said.

How will individuals suffer?

JP Morgan economist Michael Feroli has estimated that more than $550bn could be sucked out of the economy. "In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that," he said. The US-based Tax Policy Center (TPC) estimates that the average annual tax bill for each American would rise by $3,500. The super-rich face an average tax rise of $120,500 a year, while the lowest earners will see an increase of about $412. For the middle earners - about 60% of the population - the TPC estimates that the average annual tax rise would be about $2,000.

Surely there is scope for compromise?

Yes. And that is what all of the meetings in Washington have been trying to find. Some analysts believe the problem is the very notion of a fiscal cliff itself; the idea of an all-or-nothing deadline after which the US economy could be forced into the abyss. Policymakers should, instead, be talking of a fiscal obstacle course - a series of barriers that should be looked at individually and make compromise easier. There may even be an opportunity for positive change, some argue, as policies that don't have any economic benefit can be replaced for tax changes or spending decisions that promote growth.  Getting rid of the Bush-era tax cuts for higher income earners (a focus of debate in Washington) would have a negligible impact on economic growth, they argue. Whereas some of the automatic budget cuts would do harm.  "Policymakers and economic commentators should stop talking about the upcoming fiscal cliff and talk more plainly about what is needed," the two economists say, arguing that economic growth should be the priority in all policy decisions.

Any sign that Congress and the administration are taking this on board?

Republicans control the House of Representatives in Congress, and enjoy a blocking minority in the Democrat-controlled Senate, while the Democrat President Obama wields a veto, so any deal will need to be backed by both political parties. Republicans seem to be coming round to the need for high income earners to pay more taxes. However, most Republican members of Congress have publicly pledged not to raise taxes. President Obama however has claimed that such measures simply wouldn't raise enough tax to be worthwhile. He continues to insist that the Bush-era tax cuts for the wealthiest 2% must be allowed to expire. The Republican Speaker of the House of Representatives, John Boehner, has also offered to allow the tax cut to expire just for those earning more than $1m as part of a compromise "Plan B" offer. But that has now been scrapped due to lack of support from his own party.  President Obama has previously insisted that taxes must rise on all those earning in excess of $250,000, but has offered to raise that threshold to $400,000. He also offered a change to the way Social Security cost-of-living adjustments are made for some recipients, cuts to government healthcare programmes, and called for a two-year extension of the debt ceiling.

Is there a way forward?

This whole issue has been characterised by brinkmanship, with neither side refusing to blink first.

But as the collapse of the Republican Plan B shows, even when President Obama and Mr Boehner do make concessions, they cannot be sure of bringing the rest of their party with them. Mr Boehner's lack of control over the more extreme members of the Republican party is seen by analysts as both a liability, because of the difficulty carrying their votes, and an asset, as a way of forcing more concessions from the president. But although the language on either side has sounded more conciliatory since the elections, the gap between their respective positions remains substantial. Most analysts agree, however, that a deal will be done, because the alternative for both sides is so unpalatable.

^ I think that all parties involved: Republicans and Democrats from the House of Representatives, the Senate and the Presidency need to buckle-down and start doing the job that the voters put them in charge of. I doubt that any real agreement will be reached before the deadline. I think they may make an extension that will simply push the problem into the future as they did in the past. Where are all those politicians that claimed they were going to Washington to make it work again? I guess they are all on vacation. ^

http://www.bbc.co.uk/news/business-20237056