A little more on the “fiscal cliff” the U.S. is facing at the end of the year, and then we’ll drop it until after the November presidential election. What follows is some more on why we should worry, and a few words from Deutsche Bank on why we should keep things in perspective.
As noted in this space on Wednesday, the Federal Reserve is rather troubled about what damage the divided U.S. Congress might cause on the eve of 2013. Revenues are set to jump by some 30 per cent over two years, as temporary tax cuts expire, according to the Congressional Budget Office. At the same time, the $1-trillion in arbitrary spending reductions over ten years that were agreed last year are scheduled to begin.
The combination will do wonders for the U.S.’s ugly balance sheet, putting the government on a path to narrow the debt to 65 per cent of gross domestic product by 2020. But the Fed believes this is too much fiscal consolidation at too rapid a pace for the fragile economic recovery to bear.
“It’s very important to say that if no action were taken by the fiscal authorities, the size of the fiscal cliff is such that there is, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy,” Fed chairman Ben Bernanke said Wednesday.
“As I have said many times before it is imperative for Congress to give us a fiscal policy that achieves two principle objectives. The first is to achieve fiscal sustainability over the longer term. That is critical and something that needs to be addressed. At the same time I think that can be done is a way that doesn’t endanger the short-term recovery of the economy. And I am concerned that if all of the tax increases and spending cuts that are associated with the current law take place…that would be a significant risk to the recovery.”
This is more than a matter of concern for the Fed and Mr. Bernanke. The IMF said last week that the fiscal cliff is a threat to U.S. growth that is similar in scale to that posed by the European debt crisis. The Bank of Canada factored for fiscal consolidation in the U.S. equal to four percentage points of GDP between 2012 and 2014, including the winding down of stimulus programs, the ending of temporary tax cuts and the spending reductions agreed as part of the deal last year to raise the debt ceiling.
“The projected increase in U.S. real GDP growth between 2013 and 2014 is highly contingent on the expected profile for fiscal policy,” the Bank of Canada says in its latest Monetary Policy Report.
All of these dark scenarios assume Congress will do nothing about the issue. While U.S. lawmakers have done little to engender confidence over the last couple of years, they have a knack for averting at least the worst-case scenario. Joe LaVorgna and the economists at Deutsche Bank in New York say the harbingers of doom over the fiscal cliff are failing to take this political reality into account.
The CBO’s scenario assumes the Alternative Minimum Tax, a surcharge that falls squarely on the middle class, won’t be raised, diverting $89-billion to the government’s coffers. But lawmakers for years have taken steps to blunt the impact of this tax, and Mr. LaVorgna sees no reason to think that will change now. Mr. LaVorgna also points out that the CBO baseline assumes $19-billion in Medicare payments to doctors won’t be made – a political implausible scenario that quite likely will be reversed. Finally, among the scheduled tax “increases” is an end to a partial exemption of levies on investment property valued at $45-billion. Because companies have to make the decision to build capital infrastructure to take advantage of the tax break, Mr. LaVorgna doesn’t see this as a tax increase, per se.
Therefore, Deutsche Bank reckons the fiscal drag is closer to $200-billion, about half the estimate most others are using. That’s about 1.6 percentage points of GDP. As a result, Mr. LaVorgna is sticking with an aggressive estimate for U.S. economic growth of about three per cent in 2013, which is on the high end of the range of forecasts.
Without any fiscal consolidation at all, the U.S. economy would expand four per cent next year, Mr. LaVorgna says.