Beyond the US fiscal cliff

Here is a typical news headline today, “Fiscal Cliff: IMF says more to be done” So what is the fiscal cliff and why does more need to be done?

obamaFiscal cliff is the popular shorthand term used to describe the conundrum that the US Government faced at midnight 31 December 2012. The main elements of the fiscal cliff were the expiring “Bush tax cuts” from 2001-2003; expiring extended unemployment insurance benefits; an expiring payroll tax cut; automatic spending cuts worth US$110 billion per year, spread equally across defense and domestic programs (called a sequester); and the debt ceiling, the statutory limit on how much the Treasury could borrow. The double whammy of tax increases and spending cuts would have pushed the still fragile US economy over the fiscal cliff into a recession aggravated by the constraints of the debt ceiling.

This conundrum was known since August 2011 and lawmakers had 507 days to address the problem. Yet, the deal that was reached to avert the fiscal cliff happened after the deadline of midnight 31 December 2012. The Senate passed the necessary resolution three hours after the deadline and the House 24 hours later. While the financial impact of the delay is negligible, the failure to agree on a solution until the final hours underlines yet again the deep polarity between the two main political parties and among the American population generally.

The current deal

Fiscal CliffThe deal that was cobbled together at the last minute did avoid the worst of the problem but it was not the “grand bargain” that some had hoped for with the re-election of President Obama on a convincing majority. It covers only the Bush tax cuts where some compromises were made, and enhanced unemployment insurance benefits which will continue for one more year. The payroll-tax cut will expire as scheduled, sapping workers purchasing power by about $1,000 each.

The sequester, which was due to take effect this week, will be delayed for a few months. Meanwhile, the Treasury can use various accounting maneuvers for about two months before it completely runs out of room to borrow without an increase in the debt ceiling. At that point, it will have to stop paying some bills e.g. to pension beneficiaries, soldiers, Medicare doctors, and perhaps eventually bondholders, bringing on default. Permanently replacing the sequester and raising the debt ceiling will require intensive new negotiations likely to begin as soon as the current deal is signed into law. This is not going to be easy!

The next deal

Since the summer of 2011 Republicans have insisted on deep cuts to spending as the price of raising the debt ceiling, even if it means risking a default. Some will be doubly determined to pursue that strategy now. They complain that the current deal does nothing to alter the long-term upward trajectory of the debt. In the meantime, Mr Obama signaled that he was equally determined that taxes have to rise further. As he put it: “If Republicans think that I will finish the job of deficit reduction through spending cuts alone…they ‘ve got another thing coming.”

Well, tighten your seat belt for the next round of negotiations which wont be pretty and the outcome is very much unknown. It does not need to be this way. The lyrics of Andy Williams’ famous song, The Impossible Dream, come to mind – “to dream the impossible dream … and the world will be better for this”.

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