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Get ready for the next ‘fiscal cliff’

The corridor that leads to the floor of the U.S. House of Representatives is empty late Monday with no voting expected on a ‘fiscal cliff’ deal before the midnight deadline.

J. Scott Applewhite/AP

We enter 2013 without a resolution to the vexing "fiscal cliff" problem in the United States.

A deal, however, appears to be forthcoming, with President Barack Obama laying out a plan he believes can win approval in both the House of Representatives and the Senate. Any progress to settle the issue (which refers to the combined impact of federal spending cuts and tax increases) is welcome, but optimism should be cautious at best. Even if Mr. Obama can finalize the deal, he has only postponed, not solved, the problem.

The move that will receive the most attention would be the permanent ending of the Bush tax cuts on individual income of more than $400,000 (U.S.) and on family income of more than $450,000, but letting them continue for everyone else.

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Less headline-worthy, but arguably more important, are moves to extend unemployment benefits, small-business tax credits, credits for wind power, and the earned-income and child tax credits. Unfortunately, all of these moves are temporary; many would require renewal in a year's time, paving the way for a second "fiscal cliff" a year from now.

There are still grave issues for the months ahead. Mr. Obama's proposal does not cover a series of automatic spending cuts that are staggered throughout 2013. The uncertainty around these will slow U.S. economic growth, with government employees who worry that they may lose their jobs naturally reducing their own spending.

The biggest failure of the proposal is that it does not address the debt ceiling, which requires an increase by March at the latest. Even if Mr. Obama's plan passes, he has bought himself only a few weeks of policy certainty. If the events of 2011 offer any guide, expect to see additional tax and spending reforms in exchange for Republican support for raising the debt ceiling. Any deal on the debt ceiling will not come quickly, however. Rather we will see the usual brinkmanship games, which will further erode consumer and investor confidence.

The best way to judge the impact of any economic event is to look at the market reaction. After Mr. Obama's statement on Monday, the Dow Jones Industrial Index and the price of West Texas Intermediate crude oil both rose – but each by less than 1 per cent. Markets did not love his announcement, but did not hate it, either. Given that his proposed deal delays rather than eliminates the "fiscal cliff," that response and lack of enthusiasm is appropriate.

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About the Author

Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University. Mike also does private sector consulting for the chemical industry. More

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