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The Economist: Stepping back from the 'cliff'

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The author of this entry is responsible for this content, which is not edited by the Wilson County News or wilsoncountynews.com.
Dr. M. Ray Perryman
January 3, 2013 | 2,823 views | Post a comment

Leave it to Washington to push us to the brink...again. Action to avoid the fiscal cliff was delayed until the last possible moment (even pushing votes past midnight on the 31st so that no one would technically violate a pledge that’s only meaning is political), despite the dire potential consequences that every economist, market observer, businessperson, media outlet, community leader, thinker, and reasonably well-informed second grader was aware of. While the deal isn’t perfect (regardless of your political stance), at least it was a deal that undid the other prior deals that came about because they can’t ever seem to get to a “big deal.”

Without a bill, the two-fisted assault on the economy of expiring tax breaks and automatic spending cuts would have curtailed growth and possibly sent the United States backsliding into another recession. Given the modest pace of expansion we have been experiencing and ongoing weakness in key areas (such as hiring), the economy was particularly vulnerable and the fallout from the cliff would have been magnified. Federal Reserve (Fed) Chairman Ben Bernanke stated as early as last summer that if no action was taken by the fiscal authorities (Congress and the Administration), he thought there was “absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy.”

Given what was at stake, it’s hard to see why legislators from both sides of the aisle and the administration couldn’t find a way to avoid a last-minute crisis. However, the issues go beyond mere partisanship, tracing roots back to earlier showdowns about the budget and the debt ceiling as well as policy aimed at shortening the recent recession. Add to that the strong statements the President (and many House and Senate members) made during the election season, which worked to decrease the potential for compromise. At the end of the day, progress was made on one front (the tax piece) and put off for a couple of months on the other (the automatic spending cuts).

The final bill raises about $600 billion in additional taxes over the next 10 years. All wage earners will pay additional Social Security tax with the expiration of a temporary cut implemented two years ago as part of a stimulus package. The average household (with income of $50,000) will pay about $1,000 more in 2013 than last year. In addition, the tax rate for individuals who earn $400,000 ($450,000 for households) will go from 35% to 39.6%; rates on other types of income, such as capital gains and dividends, will also rise for this income group. The agreed upon $400/$450k threshold is higher than the $200,000 and $250,000 proposed by President Obama, but lower than the $1,000,000 proposed by House Speaker John Boehner.

Important tax credits were also extended, including the Child Tax Credit, Earned Income Tax Credit, and others. Long-term unemployment benefits were also extended for another year, and a long-overdue provision to automatically adjust the Alternative Minimum Tax (AMT) income threshold with inflation was included. Medicare reimbursement rates to doctors were kept at current levels for another year, staving off a 27% cut which would have kicked in otherwise.

The best aspect of the deal is that something was actually done. No, it’s not perfect, but the level of dysfunction which would have been displayed if Washington had not been able to reach any semblance of agreement (given the enormity of what was at stake) is rather scary to contemplate (and almost happened in the House). Other good things are that the AMT was fixed and the income thresholds for the top tax levels were bumped up high enough to spare people earning high incomes, but certainly not falling in the “1%.”

The worst aspect of the deal is that it totally punted on the issue of the “sequester” (the $110 billion in automatic government spending cuts) and other key problem areas such as entitlement program reforms and rationalization of the tax code. Better a punt than a cliff, but the showdown shaping up for this spring is likely to be exceedingly ugly. Not only will we need to find a real fix for the sequester, but also take action on the debt ceiling. Given the absolutely essential requirement that the United States pay the sovereign debts it has already incurred, the issue should be one that is handled quickly and seamlessly with no controversy. But, alas, in today’s world, that is not to be. Treasury Secretary Timothy Geithner has indicated the Treasury will be using “extraordinary measures” to avoid hitting the debt ceiling until the end of February, but something will have to be done at that point. In addition, the current budget resolution is set to expire at the end of March, and it has been years since a budget bill has actually been passed on time.

On balance, I think the deal could have been better, but it’s certainly preferable for the economy that there was a deal at all. Now comes the difficult task of avoiding yet another crisis in just two months and, ultimately, tackling the very real issues that must be addressed in a systematic and intelligent manner.

Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.
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