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Peter Hall


Will the U.S. Pull us All Over its Fiscal Cliff?

Posted: 11/15/2012 12:29 pm

It's coming, and it's big. The U.S. economy is careening toward the so-called fiscal cliff at a frightening pace, and it's creating a lot of concern. With the election now decided, will legislators seal a deal that allays these fears, or will political sclerosis drive America -- and the world -- to the precipice?

If it did, it would be a shame. Consumers -- 70 per cent of the U.S. economy -- are spending at a rapid clip while simultaneously mending their personal finances. Housing markets have turned the corner -- residential construction is up 35 per cent, and yet has a long way to go before it hits normal levels. Even shattered U.S. consumer confidence seems to be on the mend. At the same time, corporate America is in great shape: profits are near an all-time high, and businesses are sitting on a $5.7-trillion mountain of cash and near-cash. Is the present whiff of recovery incentive for action?

Under current U.S. law, previously delayed spending reductions will kick in early in 2013. Together with tax cuts that are set to expire on December 31, 2012, the spending resets would slap the U.S. with a fiscal tightening equivalent to a massive 5.1 per cent of GDP -- enough to plunge the American economy into a second severe recession in a matter of weeks.

Little could be done ahead of the November 6 election. As such, frantic deal making and negotiations have commenced, and are likely to intensify through the dying days of 2012. Will they succeed? The U.S. Constitution establishes checks and balances with the intention of limiting the power of any one branch of government, in essence, forcing brinksmanship, compromise and deal making. These types of debates, though rancorous, are an historic feature of the U.S. legislative process, although they have not prevented the current administration from passing tough, contentious legislation.

In fact, the legislation needed to address most parts of the fiscal cliff will be far easier to pass than the highly charged medicare and financial bailout bills, as there is broad, bipartisan agreement on details. Reductions in payroll taxes and tax cuts for the middle class enjoy broad support, while both parties would be loath to make deep cuts to defence.

Proper assessment of the likely impact of the fiscal cliff requires examination of each component of the forthcoming tax increases and spending cuts and assumptions about expected agreements and compromises. This leads to a projected fiscal tightening amounting to just 1.4 per cent of GDP. CBO output multipliers suggest a total economic impact worth 1.5 percentage points of U.S. GDP.

Given economic momentum, this fiscal drag will hit an economy that's sporting underlying growth of 4.3 per cent. Netting out the 1.5 per cent fiscal impact still leaves a 2.8 per cent economy -- true, not terribly exciting, but the underlying strength is -- and that's the part of the U.S. economy where most Canadian exporters are doing business. As the global economy's true powerhouse pulls it toward a real and lasting recovery, Canadian exporters should prepare to harness the new growth.

The bottom line? Concern about the potentially devastating impact of a full U.S. fiscal cliff is well-placed. That fear is the very catalyst that will keep legislators -- none of whom wants their name on the U.S. or global economy's epitaph -- at the table hammering out a workable and practical deal.

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  • The Deficit Has Grown Mostly Because Of The Recession

    The deficit has ballooned not because of specific spending measures, but <a href="http://research.stlouisfed.org/fred2/graph/?s[1][id]=FYFSD" target="_hplink">because of the recession</a>. <a href="http://www.whitehouse.gov/omb/budget/Historicals" target="_hplink">The deficit more than doubled</a> between 2008 and 2009, as the economy was in free fall, since laid-off workers paid less in taxes and needed more benefits. The deficit then shrank in 2010 and 2011.

  • The Stimulus Cost Much Less Than Bush's Wars, Tax Cuts

    Republicans frequently have blamed <a href="http://projects.nytimes.com/44th_president/stimulus" target="_hplink">the $787 billion stimulus</a> for the national debt, but, when all government spending is taken into account, the stimulus frankly wasn't that big. In contrast, <a href="http://www.huffingtonpost.com/2011/06/29/cost-of-war-iraq-afghanistan_n_887084.html" target="_hplink">the U.S. will have spent nearly $4 trillion</a> on wars in the Middle East by the time those conflicts end, according to a recent report by Brown University. <a href="http://www.washingtonpost.com/blogs/fact-checker/post/revisiting-the-cost-of-the-bush-tax-cuts/2011/05/09/AFxTFtbG_blog.html" target="_hplink">The Bush tax cuts have cost nearly $1.3 trillion</a> over 10 years.

  • The Deficit Grew Under George W. Bush

    When George W. Bush took office, <a href="http://www.whitehouse.gov/omb/budget/Historicals" target="_hplink">the federal government was running a surplus</a> of $86 billion. When he left, that had turned into a $642 billion deficit.

  • The Deficit Is Shrinking

    <a href="http://www.whitehouse.gov/omb/budget/Historicals" target="_hplink">Last year's federal budget deficit</a> was 12 percent lower than in 2009, according to the Office of Management and Budget.<a href="http://www.whitehouse.gov/omb/budget/Historicals" target="_hplink">The deficit is projected to shrink</a> even more over the next several years.

  • Investors Are Paying Us To Borrow Money

    <a href="http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield" target="_hplink">The interest rate on 10-year Treasury bonds</a> is <em>negative</em>, according to the Treasury Department. Investors are even paying us for 30-year Treasury bonds, when adjusted for inflation.

  • Investors Are Not Running Away

    <a href="http://www.businessinsider.com/niall-ferguson-has-been-wrong-on-economics-2012-8" target="_hplink">Conservative commentators</a> have been warning for years that investors will run away from Treasury bonds because of the national debt. So far it's not happening. <a href="http://www.huffingtonpost.com/2012/05/30/treasury-yield-record-low_n_1555975.html" target="_hplink">Interest rates on Treasury bonds</a> continue to hover at historic lows.

  • Health Care Reform Reduces The Deficit

    <a href="http://www.huffingtonpost.com/2012/09/04/republican-platform-2012-factual-mistakes_n_1840795.html#slide=1461142" target="_hplink">Republicans have blasted the Affordable Care Act</a> as "budget-busting." But <a href="http://www.huffingtonpost.com/2012/09/04/republican-platform-2012-factual-mistakes_n_1840795.html#slide=1461142" target="_hplink">health care reform actually reduces the deficit</a>, according to the Congressional Budget Office.

  • The U.S. Is Borrowing Less From China

    <a href="http://krugman.blogs.nytimes.com/2012/08/30/fear-of-china-syndrome/" target="_hplink">The U.S. government is borrowing much less from foreign countries</a> than before the recession, according to government data cited by Paul Krugman. That is because the U.S. private sector is financing our bigger deficits.

  • We Spend A Lot On Defense

    <a href="http://www.cbpp.org/cms/index.cfm?fa=view&id=1258" target="_hplink">Defense spending constituted 20 percent</a> of federal spending last year, or $718 billion, according to the Center on Budget and Policy Priorities. This adds up to <a href="https://twitter.com/AJInsight/statuses/241269134996959234" target="_hplink">41 percent of the world's defense spending</a>, according to Bloomberg TV anchor Adam Johnson. <a href="http://www.huffingtonpost.com/2012/07/19/mitt-romney-military-budget_n_1687601.html" target="_hplink">Mitt Romney has vowed</a> to not cut defense spending if elected president.

  • We Spend A Lot On Health Care

    <a href="http://www.cbpp.org/cms/index.cfm?fa=view&id=1258" target="_hplink">Health insurance, including Medicare and Medicaid, constituted 21 percent</a> of federal spending last year. In contrast, education constituted 2 percent of federal spending. Meanwhile, <a href="http://www.miamiherald.com/2012/08/19/2956609/middle-aged-blues-over-paul-ryans.html" target="_hplink">Mitt Romney and Paul Ryan have promised not to change Medicare</a> for Americans age 55 and older.

  • Republicans May Want Large Deficits For Now

    <a href="http://www.businessinsider.com/corporate-taxes-deficits-and-labor-vs-capital-during-reagans-first-term-2012-7" target="_hplink">The federal budget deficit ballooned</a> under Ronald Reagan, and that may be just the way Republicans like it. <a href="http://www.forbes.com/2010/05/06/tax-cuts-republicans-starve-the-beast-columnists-bruce-bartlett.html" target="_hplink">Some Republican thinkers</a> have proposed <a href="http://www.nytimes.com/2010/02/22/opinion/22krugman.html" target="_hplink">"starving the beast"</a>: that is, cutting taxes in order to use larger deficits to justify spending cuts later. Since Republicans ultimately want lower taxes and a smaller government, what better way is there to cut spending than to make it look urgent and necessary?