US policy change could see us facing fiscal cliff

The election of Barack Obama for a second term as US president is, like a curate’s egg, a mixed blessing.

From a political perspective, it is good — it shows the US electorate is not willing to give credence to a party that has become more and more illiberal, more and more unwilling to engage in real-world politics, more and more entrenched in ideological purity, and less and less connected to the real challenges facing the US.

A reinvigorated Republican party, purged of its lunatic fringe, open to real reform on immigration and the economy, cannot be but a good thing for US politics and, by extension, the US and the global economies.

Economically, the situation is less clear. One crucial issue is whether or not the US House of Representatives, still Republican-dominated, will accept that bipartisanship is required. If they continue to stall, filibuster, and obfuscate then there is no hope of a strong US.

The most immediate problem facing Obama on the economy is the so-called fiscal cliff — a combination of tax increases and spending cuts scheduled to kick in from early 2013.

A large part, possibly up to $2tn (€1.5tn) of the record US deficit, can be attributed to the massive tax cuts of the Bush era. This is as much as the cost of the wars of that administration.

A difficulty, however, is that while rowing back these tax cuts may make economic and social sense, increasing taxes when the economy is only beginning to recover is a risky proposition. A particular problem is that some of the tax cuts being repealed will impact not just the wealthy — a rise in capital gains from 15% to 20% — but also on the lower paid. However, the US is also running a massive deficit and its debt now stands at $16tn, or 100% of GDP. As a consequence, increased tax takes are needed. But the US also faces cuts to defence and non-defence spending, taking over $100bn out of the economy each year through 2020. The combination can deal a significant blow to US and world growth.

A deal needs to be struck whereby some tax increases are made and some additional infrastructure spending undertaken, as urged by the IMF. That, however, will require the House to overcome its Republican repugnance to government spending and tax hikes. If the US drives over the fiscal cliff, it will be the Republicans who have steered it.

Beyond that, history suggests we should welcome a Democrat back in the White House. There is strong evidence that, under Democratic presidents, the US stock market significantly outperforms compared to Republican presidents.

This out-performance is significant — up to 16% for small-cap stocks. To some degree, it can be explained by increased risk during Democratic presidencies. Therefore, if history is any guide, we should see the US market boom as it has done since 2009.

More generally, Republican presidents, especially in the last half-century, tend to get low marks for economic management. For all the Republican rhetoric on sound fiscal policies, their record is fairly dismal when it comes to debt.

Ronald Reagan and Bush Sr presided over a doubling of the US debt/GDP ratio from 30% to 60%. Clinton stopped the rot, only to have the wars and tax cuts of Bush Jr take the ratio from below 60% to 90%. Faced with a Tea Party-infused Congress, Obama has made no headway on this to date. In terms of jobs, the US unemployment rate under Republican presidents is marginally higher than under Democrats, and inflation is little different.

Taken all together, therefore, the last half-century suggests that Democratic presidents tend to preside over economic good times compared to their Republican rivals. A growing, strong US, as one of our larger economic partners, is a good prospect for Ireland. But it is not all good news.

Ireland needs to be careful. The increased focus on offshore tax havens and homes will inevitably bring Ireland back into focus. We have already seen how ruthless the US Treasury can be when it comes to protecting what it sees as US interests.

We should not assume our tax status will continue to be as it has been. Any change in this status would throw up very interesting quandaries for US firms headquartered in Ireland. Add to that the desire by Obama to make offshoring of tax by US corporates less palatable, and we face a potential fiscal cliff of our own.

Taken together, Obama’s victory is good news. But, like all good news, it needs to be managed. And we need all the help we can get in an economy which is flat-lining.

* Brian Lucey is professor of finance at Trinity College Dublin

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