Is the US set to jump off a fiscal cliff?

Without serious, structural fiscal reforms — which require bipartisanship and compromise — the US economy could go into free fall. Bungee jump image from www.shutterstock.com

As we check our political calendars, many look to November 6 as the crucial date that will determine the future direction for US politics and the nation’s ailing economy.

But in policy terms, it is January 2nd, 2013 that arguably matters more. That is the day of reckoning for federal government spending in the United States. During last year’s dramatic Congressional showdown over raising America’s debt ceiling (to honour payments to foreign creditors), it was agreed by a petulant congress that automatic cuts would occur on January 2, 2013. This is also when the so-called Bush tax cuts of 2001 will expire.

This date is dubbed the “fiscal cliff” because of the dramatic changes to the government’s revenue and expenditure that will be brought about by the automatic changes set to take place that day: over $400 billion worth of tax cuts will expire at the same time as about $100 billion of spending decreases are implemented. Many predict that this will likely send the economy into a double-dip recession.

The Congressional Budget Office estimates a drop in the deficit by about $560 billion between the 2012 and 2013 fiscal years, but the short-term effect is a dampening of economic growth and increased unemployment in an already sputtering economy.

Most analysts and elected officials agree that something must be done by Congress to avoid the automatic changes it set in motion last year as a political dare to inaction. The opening positions are that the Republicans want all the Bush-era tax cuts to be extended, while Democrats argue that long-term spending cuts should also be offset by tax increases for those earning over $250,000 a year.

The problem is that the system requires bipartisanship and compromise. However, because power is currently shared by a Republican House and Democratic Senate — and ill will is running high – compromise will be particularly hard to achieve. Furthermore, any bill without widespread partisan approval will be blocked in the Senate by the threat of the filibuster; if it passes that hurdle it could still be vetoed by the president.

The current thinking is that there are three possible scenarios for the coming months. The Obama administration could cross their fingers and hope that Congress can reach a deal. The second option is that Obama could go bold and head straight for the cliff. He could declare that if Congress is unable to strike a deal on fiscal reform, he will allow the “double fiscal time bombs” to explode. The hope is that this will cause Republicans to abandon their commitment not to raise taxes and force them to the negotiating table. The problem is this will take the iron will of LBJ or FDR. Many wonder whether a president who ran in 2008 on a promise of compromise has such grit in him.

Alternatively, Washington could do nothing — close their eyes and jump off the fiscal cliff. Despite the short-term consequences, commentators are increasingly suggesting that this wouldn’t be such a bad thing. It would allow the debate to “reset”. Taxes would automatically increase in the New Year when the Bush tax cuts expire; if this was allowed to happen then in 2013, lawmakers would be able to enjoy the political benefits of cutting some of the new hikes rather than being blamed for raising taxes.

In the meantime, the uncertainty over what will happen come January is taking its toll today. In July, supply chain management company, UPS - often considered a gauge for future economic performance - downgraded its growth estimates for the rest of the year, partly due to uncertainty over the likely outcome.

Although Congress is ultimately the forum where tax and spending reforms will be decided upon, we are likely to hear more about the fiscal cliff in the coming weeks in the presidential campaign. The Obama campaign is arguing that Romney’s solution to every problem is tax cuts for America’s highest income earners. Obama even had a tax joke in his convention speech: “Feel a cold coming on? Take two tax cuts, roll back some regulations, and call us in the morning!” Romney argued this weekend that “President Obama is passively allowing us to go over a fiscal cliff”.

Insider accounts of the debt crisis such as Bob Woodward’s latest fly-on-the wall book, The Price of Politics, finds plenty to fault about Obama’s negotiating skills during these very tricky and important debates. However, Romney and Ryan’s solutions to America’s debt problem – which they suggest is like a wildfire sweeping across America – are likely to leave lots of poorer Americans worse off at a time when poverty is already at a two-decade highpoint in America. Watching the fiscal cliff negotiations in the months ahead is thus just as important as watching the Obama and Romney popularity contest.