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America's 'fiscal slope' deadlock

While the doomsday scenario is an exaggeration, any deal is unlikely to solve the country's structural financial issues.
Last modified: 11 Dec 2012 05:10

If what you see and what you read are to be believed, America is in a panic.

As the country gears up for the Holiday season and the New Year, it faces what's become known as the 'fiscal cliff'.

For years, Republicans and Democrats have argued about tax cuts and spending plans. But last year, the fight was particularly nasty. Republicans refused to allow more spending unless there was movement on taxes. The deadlock threatened America's ability to pay its bills and meet its commitments. The uncertainty led to an unprecedented downgrade in the US credit rating and severe wobbles in the international financial markets before agreement was reached to raise the debt ceiling, the level to which the country could raise money.

To try to avoid a repetition, a 'supercommittee' was formed with senior figures from both parties to agree a deal on $1.2 trillion in targeted budget savings over ten years. The idea was introduce tax and spending reforms and share the pain for both sides. As an incentive to reach a deal, a plan was agreed that would automatically trigger tax rises and spending cuts. It didn't work. There was no deal, and now the Budget Control Act of 2011 will go into effect at midnight on December 31st. The country will go off the 'fiscal cliff'.

What that means is that more than 1000 government programmes including the defence budget and health care provision for the elderly face deep automatic cuts. And temporary tax cuts will end, meaning a 2 percent rise in tax for every worker. It's estimated the average family will be paying around $2000 more a year in taxes, the shock to the financial system could throw America - still the world's biggest economy - in recession.

The reality is though the fiscal cliff won't mean immediate economic devastation. At any point, Congress and the White House could reach a deal which would kill any of these measures. An agreement could put together in the first days and weeks of the New Year before any of the doomsday changes begin to bite. It's not so much of a cliff, more of a slope.

Both parties seem reluctant to sort things out. With one eye on the endless campaigning that exists in the US and the midterm elections in 2 years, the Democrats are arguing against changing entitlement programmes and insist there must be higher taxes for anyone earning over $250,000. The Republicans continue to stick to their pledge not to raise tax rates, instead talk about changing the tax code and removing allowances. Some Republicans have begun to acknowledge rates must be raised to get a deal. Rightwing commentators say this could spark a civil war in the party.

Barack Obama and the speaker of the House, the senior Republican John Boehner, talked face to face on Sunday and some observers suggest that means a big announcement could follow.

But there's a worry that any deal will probably be short term. It will be passed by a lame duck Congress which will have little time to debate the full implications on the economy and important social safety nets because the artificially created deadline. It will however, allow both parties will argue they have to have 'something' to take back to their supporters.

What it is unlikely to do is lay the foundations to stop such panic in the future while addressing the major structural issues of America's finances.