Political brinksmanship still threatens US economy
Mark Zandi, chief economist at Moody's Analytics, calculates that the higher payroll tax will reduce economic growth by 0.6 percentage points in 2013. The other possible tax increases - including higher taxes on household incomes above $450,000 a year - will slice just 0.15 percentage points off annual growth, Zandi said.
The fiscal cliff itself was created to force Democrats and Republicans to compromise, and it succeeded - barely.
To end a 2011 standoff over raising the federal debt limit, they agreed to a Jan. 1, 2013 deadline to reach a deal over taxes and spending. If they didn't, more than $500 billion in tax increases would hit the economy in 2013 alone, along with $109 billion in cuts from the military and domestic spending programs. The sharp tax hikes and spending cut would threaten to send the economy over the cliff and back into recession.
But negotiations to avert catastrophe have highlighted once again how far apart the two parties are on taxes (Republicans don't want to raise them) and spending (Democrats are reluctant to cut government programs).
Ethan Harris, co-head of global economics at Bank of America Merrill Lynch, asked: "What induces the two sides to stop fighting and start compromising?"
Political gridlock has been rattling financial markets and shaking consumer and business confidence the past two years.
After a fight over raising the debt limit last year, the credit rating agency Standard & Poor's yanked the U.S. government's blue-chip AAA bond rating because it feared that America's dysfunctional political system couldn't deliver a credible plan to reduce the federal government's debt. S&P cited an overabundance of "political brinksmanship" and warned that "the differences between political parties have proven to be extraordinarily difficult to bridge."
The Dow Jones industrials dropped 635 points in panicked selling the first day of trading after the S&P announcement.
Outside Washington the economy has been getting some good news. Europe's financial crisis appears to have eased, reducing the threat of a renewed financial crisis. And the U.S. real estate market finally appears to be recovering from the housing bust.
But the old worries have been replaced by new ones about political gridlock, says Joseph LaVorgna, an economist at Deutsche Bank.
The partisan divide has left businesses and consumers wondering what's going to happen to their taxes and to federal contracts.
Companies have plenty of cash. But they reduced spending on industrial equipment, computers and software from July to September, the first quarterly drop since mid-2009 when the economy was still in recession. And hiring has been stuck at a modest level of about 150,000 new jobs per month this year.
Consumer confidence fell in December for the second straight month, according to a survey by the Conference Board, which blamed the drop on worries about the fiscal cliff. The uncertainty is also believed to have dinged holiday shopping, which grew at the slowest pace this year since 2008.
Many economists are disappointed that Congress and the White House couldn't reach agreement on a broader deal that significantly reduces the deficit over the next 10 years. That could have boosted business and consumer confidence and accelerated growth .
No progress has been made on reforming the government's big entitlement programs, mainly Medicare and Social Security.
"Nothing really has been fixed," Lavorgna says. "There are much bigger philosophical issues that we aren't even addressing yet."
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