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Deadline looms for US "fiscal cliff"

Published: 12/31/2012
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With a day left to negotiate, US Democrats and Republicans appear unlikely to reach a comprehensive deal before automatic tax increases and spending cuts come into force tomorrow (1 January 2013).



IHS Global Insight perspective

 

Significance

A shift to new negotiators suggests that the US will not seal a congressional compromise to avert tomorrow's "fiscal cliff".

Implications

However, a compromise is nevertheless likely to be reached.

Outlook

It is possible that the parties may succeed in agreeing a short-term measure today to reassure financial markets while a permanent solution is discussed.

Slow talks

Financial markets are bracing for trouble, as US legislators continue to note significant divisions over how they would prefer to close down the government's over-USD1-trillion fiscal deficit. Today (31 December) London's FTSE100 index looked set to fall below 5,900 as traders fled the risks presented by the "fiscal cliff", which IHS Global Insight forecasts will see US growth decline at an annual rate of -2.4% in the first quarter of 2013 (instead of growing 2.2%). The latest figures for US consumer confidence suggest it dived dramatically in December, falling 6.4 points on fears of sharply higher taxes in 2013 as a result of the "cliff", with US consumers delaying planned purchases as a result.

One feature of US politics is that the two major parties do not have unified leaderships, but rather various prominent personalities who can take the initiative and attempt to rally their congressional caucus behind a particular set of compromises. Since his embarrassing failure to pass one such package through the Republican-dominated House of Representatives, the House Speaker John Boehner's role in the talks has faded (see United States: 21 December 2012: US Republicans face internal rift over "fiscal cliff"). Leadership of the Republican position has instead been taken up by Senate minority leader Mitch McConnell, who has approached Vice-President Joe Biden, a former senator, to negotiate on the Democrat side.

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The US Capitol is seen as Congress convenes to negotiate
a legislative path to avoid the fiscal cliff, 30 December 2012.
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Yesterday McConnell released a statement in which he accused the Democrats of a "lack of urgency" in tackling the problem, citing what he said were slow responses to Republican offers. McConnell said he had contacted Biden, as opposed to Democrat majority leader Harry Reid, because he and Biden had worked successfully to forge compromise in the past. Reid appeared to accept the move, saying that he was not yet in a position to offer a counter-proposal to the plan submitted by McConnell's Senate Republicans on 29 December.

The Republicans are seeking to limit the extent of inevitable tax increases implied by the cliff, whereas the Democrats seek to protect these while preventing cuts to state benefits. Yesterday it emerged that the Democrats had successfully dissuaded Republicans from insisting on the recalibration of inflation indexes, on a "chained" basis, which would have the effect of cutting social security benefits. Senator John McCain, another high-profile Republican who has weighed into the discussions, said it was not politically feasible for Republicans to cut benefits for the poor while trying to protect tax cuts for the wealthy.

Outlook and implications

Last-minute deals are a feature of life in Washington. The fiscal cliff is itself the result of the Budget Control Act (BCA), a last-minute deal to avert sovereign default enacted in August 2011, and the December 2010 agreement to prevent the expiration of the Bush-era tax cuts (see United States: 16 December 2010: Tax Bill Passes U.S. Senate Despite Opposition from Left and Right). It remains highly likely that a deal will be forged to prevent the recession that will be created by the cliff if it is allowed to come fully into force.

However, the cliff is not a hard deadline, in the manner of the statutory debt-ceiling that prompted the BCA, and this has drained the talks of some of their urgency. The cliff could potentially be unpicked by the incoming 113th congress due to convene on 3 January 2013 with a fresh mandate, before the economic damage is realised. This now appears to be the most likely scenario, given that Biden and McConnell will need additional time to discuss the matter further. Nevertheless, a stop-gap measure could potentially be passed today to reassure financial markets.

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