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U.S. fiscal cliff: Economic shock could instigate a real fix Add to ...

Leaping off the so-called fiscal cliff is a bad option for the United States. But it might not be the worst. If U.S. politicians can’t wrangle a deal first, January will bring tax increases and spending cuts. The economic shock could bring another recession. But it could also improve the political chances of a real fix.

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The Congressional Budget Office predicts output could shrink by 0.5 per cent in 2013 if the current law isn’t changed. Tax reductions enacted under George W. Bush would finally expire and mandatory spending cuts in last year’s Budget Control Act would kick in.

The big risk would be triggering a downward economic spiral. On the other hand, the CBO reckons another consequence is that the U.S. deficit would sharply reduce in 2013, to about $640-billion (U.S.) from $1.1-trillion this year. Over a decade, federal debt would fall to just under 60 per cent of GDP from over 70 per cent this year. If deficit-reducing measures were instead postponed indefinitely, the CBO reckons that the U.S. debt-to-GDP ratio would swell to an alarming 90 per cent a decade hence.

Moody’s Investors Service even indicated on Sept. 11 that the United States would be more likely to retain its triple-A rating with a budget trajectory that looks like the fiscal cliff rather than if Congress were just to extend the status quo.  Delaying the mandatory spending cuts - which lawmakers imposed on themselves explicitly to force action if no larger plan was agreed - would badly dent U.S. credibility.

In any event, either potential occupant of the White House in 2013 would reshape the post-cliff budget within months. For Republicans, it is too heavy on tax revenue rather than cost cuts – though the Budget Control Act would lop $55-billion a year off both defence and non-defence spending. But the starting point would be closer to a sustainable path. The more cost-cut-weighted proposals of Barack Obama’s 2010 fiscal commission - rejected by both the President and Mitt Romney’s running-mate Paul Ryan, a commission member - might even find new support.

As for taxes, the expiry of the Bush rate reductions would push the top marginal federal income tax rate up to 39.6 per cent next year from 35 per cent currently. Some Republicans might not be swayed from a belief in a maximum rate of, say, 25 per cent. But those GOPers simply determined to reduce taxes would suddenly have room to negotiate.

A far less risky course would be for U.S. lawmakers to hammer out a realistic long-term plan for taxes and spending. But if they fail, the bump from the fiscal cliff-jump could quickly bring a lasting deal. That’s better than Washington continually deferring tough decisions.

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