Deal far from a ‘grand bargain’ on reducing budget deficit, say analysts

The bill removes most threats to a recovery, but many issues remain, writes Jason Lange

A deal worked out by US Senate leaders to avoid the “fiscal cliff” was far from any “grand bargain” of deficit reduction measures.

But if approved by the US House of Representatives, it could help the country steer clear of recession, although enough austerity would remain in place to likely keep the economy growing at a lesser pace.

The Senate approved a last-minute deal early yesterday morning to scale back $600bn (€454bn) in scheduled tax hikes and government spending cuts that economists widely agree would tip the economy into recession.

The deal would hike taxes permanently for household incomes over $450,000 a year, but keep existing lower rates in force for everyone else.

It would make permanent the alternative minimum tax “patch” that was set to expire, protecting middle-income Americans from being taxed as if they were rich.

Scheduled cuts in defence and non-defence spending were simply postponed for two months.

Economists said if the package were to become law, it would represent at least a temporary reprieve for the economy. “This keeps us out of recession for now,” said Menzie Chinn, an economist at the University of Wisconsin-Madison.

Roughly one-third of the scheduled fiscal tightening could still take place, said Brett Ryan, an economist at Deutsche Bank in New York.

That is in line with what many financial firms have been expecting, suggesting forecasts for economic growth of around 1.9% for 2013 would likely hold.

At midnight on New Year’s Eve, low tax rates enacted under then-president George W Bush in 2001 and 2003 expired. If the House of Representatives agrees with the Senate, the new rates would be extended retroactively.

Otherwise, together with other planned tax hikes, the average household would pay an estimated $3,500 more in taxes, according to the Tax Policy Centre, a Washington think tank. Budget experts expect the economy would take a hit as families cut back on spending.

The bill would avoid scheduled cuts to jobless benefits and to payments to doctors under a federal health insurance programme.

The estimated growth of roughly 1.9% this year would be much better than the 0.5% contraction predicted by the Congressional Budget Office if the entirety of the fiscal cliff took hold, but it would fall short of what is needed to quickly heal the labour market, which is still smarting from the 2007-09 recession.

“We continue to anticipate a significant economic slowdown at the start of the year in response to fiscal drag and a contentious fiscal debate,” economists at Nomura said.

In particular, analysts say financial markets are likely to remain on tenterhooks until Congress raises the nation’s $16.4 trillion debt ceiling, which the US Treasury confirmed had been reached on Monday.

While the Bush tax cuts would be made permanent for many Americans under the budget deal, a two-year-long payroll tax holiday enacted to give the economy an extra boost would expire. The Tax Policy Centre estimates this could push the average household tax bill up by about $700 next year.

The suspension of spending cuts sets up a smaller fiscal cliff later in the year which still could be enough to send the economy into recession, said Chinn.

He warned that ongoing worries about the possibility of recession could keep businesses from investing, which would hinder economic growth.

“You retain the uncertainty,” Chinn said.