Another Week Gone And Our Pathetic Government Still Hasn’t Resolved The Fiscal Cliff

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The Economist
Nov. 24, 2012
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Immediately following the November 6th general election, congressional leaders and the president began positioning themselves for negotiations to deal with the upcoming “fiscal cliff”, a series of budgetary measures at end-2012 that will (if not addressed) result in a severe fiscal tightening and push the US economy back into recession

The approach of the fiscal cliff has concentrated policymakers’ minds on a high-profile issue that has been a flashpoint between the two political parties. Public debate has periodically focused on how to reduce the large federal budget deficit, but deadlock in Congress has precluded agreement so far. The parties are ideologically split on how to resolve the issue, which is a key reason why more progress hasn’t been made on deficit reduction. This is no bad thing: the economic recovery has been uneven and unemployment remains elevated, so a sharp, pre-emptive fiscal tightening would have been counter-productive. However, a series of earlier tax and spending decisions means that a severe fiscal contraction is scheduled under current law to start around the beginning of 2013, raising the prospect of a return to recession if Congress does not act.

The approach of the fiscal cliff is not a new threat. The chairman of the Federal Reserve, Ben Bernanke, first alerted Congress to its existence in early 2012, but there has been no legislative action to address the issue since, and lawmakers were unwilling to take tough fiscal decisions in an election year. Moreover, some policymakers will have anticipated that they could secure a better fiscal deal if the balance of power was different after the election. Now that the election has returned a status quo-with Democrats still holding the presidency and Senate, and Republicans in charge of the House of Representatives-these considerations are no longer relevant, and public debate has swiftly turned to resolving the fiscal threat.

The president has insisted on tax rises for high incomes

Shortly after election day, Mr Obama presented his view on how the fiscal cliff should be addressed. He accepted the need for both spending cuts and revenue increases, but insisted that income tax rates on high income earners would have to rise. This is an issue on which he campaigned and won in two general elections, giving him the assurance that he is right to press the issue. The president has also long insisted that there be an alternative tax rate for those earning above US$1m per year that ensures they pay a tax rate that is at least as high as that of low-income earners (the so-called Buffett rule, named after a vaunted investor, Warren Buffett, who noted that his secretary paid a higher tax rate than he did). More broadly, Democrats are protective of the federal social security and government healthcare programmes. They tend to accept that cost growth, especially in healthcare, will become unsustainable in the longer term, but may resist immediate cuts. Republicans, for their part, tend to object to raising revenue through tax increases, preferring to maintain (or even cut) tax rates while also reducing federal expenditure in order to return the federal public finances to sustainability. These fronts have long been hardened, but the outturn of the recent election, when the electorate appeared more receptive to the Democratic message, may have opened the door to a compromise.