With President Obama’s re-election, the countdown begins for lawmakers to address the 2013 fiscal cliff and the Treasury’s statutory debt limit. But unless the President and House Republicans agree to change the current law, these crises cannot be resolved.
The other option is that Obama could decide to avoid the fiscal cliff altogether and extend current policy so that there will be no changes to taxes and spending in 2013. The US economy would improve next year as a result, but there would be no progress toward fiscal sustainability. This would force credit ratings agencies to downgrade US Treasury debt, the way Standard & Poor’s (S&P’s) downgraded the government’s credit rating on long-term securities one notch from the highest level of AAA to AA+ in 2011 (It was the first ever downgrade of US government debt). No doubt, S&P’s downgrade of the nation’s credit rating last summer had little material effect on financial markets, but that would not be the case if all the ratings agencies acted together. Further, the move would help the economy in 2013 but would significantly weaken both the fiscal and economic outlooks over the longer term. Running this scenario through the Moody’s Analytics model shows real GDP expanding 3.8% in 2013, but growing about half a percentage point lower per year over the subsequent decade.
Adding to the economic threat posed by the fiscal cliff is the approaching Treasury debt ceiling. The law currently caps federal debt at $16.394 trillion. Based on recent government expenditures and receipts, the Treasury will near that limit late this year and be forced to use extraordinary accounting techniques to avoid crossing it. However, the Treasury can only do this for so long, and by early March the Obama administration will be forced to make some difficult decisions.
While, in the short term, Obama will have to make the required adjustment in the debt ceiling, but, in the long run, the drive to fiscal sustainability needs to be powered by spending cuts rather than balanced between cuts and tax increases. In addition to freezing discretionary spending, the focus should be on putting Social Security on solid financial ground, forever. “This can be accomplished by indexing the retirement age to longevity, reducing benefits for very high income households and increasing future benefits on a more accurate measure of inflation,” says Mark Zandi, the US based Chief Economist at Moody’s Analytics. As far as taxes are concerned, the focus should be on reducing exclusions, exemptions, deductions and credits that riddle the tax code and are costing the Fed more than $1 trillion each year.
One move that perhaps can also solve the problem is the implementation of a nationwide value-added tax (VAT). In fact, B&E has suggested this option at several occasions, most recent being in March 2011 (Read: Can He Read The Writing on The Wall? Published in B&E issue dated March 31, 2011), just a few weeks before the US federal debt limit was raised to $16.394 trillion. As VAT has a broad base, it could generate enough revenue to deflate the ballooning deficit while simplifying the tax code. Considering that US consumer spending totals some $10 trillion annually, or about 70% of GDP, VAT has the potential to generate big bucks for Uncle Sam. In fact, a Congressional Research Service report suggests that each 1% of VAT has the potential to generate $50 billion. Thus, even if it’s started at a low level, say 5-10%, it can generate big money.
While all of this is doable, it won’t be easy. Not until the President and House Republicans agree to change the current law. And without an agreement on federal fiscal policy, the economy will be in recession by spring. Agreed that threat is expected to spur lawmakers to act, but not before some economic damage is done, we would say!
The other option is that Obama could decide to avoid the fiscal cliff altogether and extend current policy so that there will be no changes to taxes and spending in 2013. The US economy would improve next year as a result, but there would be no progress toward fiscal sustainability. This would force credit ratings agencies to downgrade US Treasury debt, the way Standard & Poor’s (S&P’s) downgraded the government’s credit rating on long-term securities one notch from the highest level of AAA to AA+ in 2011 (It was the first ever downgrade of US government debt). No doubt, S&P’s downgrade of the nation’s credit rating last summer had little material effect on financial markets, but that would not be the case if all the ratings agencies acted together. Further, the move would help the economy in 2013 but would significantly weaken both the fiscal and economic outlooks over the longer term. Running this scenario through the Moody’s Analytics model shows real GDP expanding 3.8% in 2013, but growing about half a percentage point lower per year over the subsequent decade.
Adding to the economic threat posed by the fiscal cliff is the approaching Treasury debt ceiling. The law currently caps federal debt at $16.394 trillion. Based on recent government expenditures and receipts, the Treasury will near that limit late this year and be forced to use extraordinary accounting techniques to avoid crossing it. However, the Treasury can only do this for so long, and by early March the Obama administration will be forced to make some difficult decisions.
While, in the short term, Obama will have to make the required adjustment in the debt ceiling, but, in the long run, the drive to fiscal sustainability needs to be powered by spending cuts rather than balanced between cuts and tax increases. In addition to freezing discretionary spending, the focus should be on putting Social Security on solid financial ground, forever. “This can be accomplished by indexing the retirement age to longevity, reducing benefits for very high income households and increasing future benefits on a more accurate measure of inflation,” says Mark Zandi, the US based Chief Economist at Moody’s Analytics. As far as taxes are concerned, the focus should be on reducing exclusions, exemptions, deductions and credits that riddle the tax code and are costing the Fed more than $1 trillion each year.
One move that perhaps can also solve the problem is the implementation of a nationwide value-added tax (VAT). In fact, B&E has suggested this option at several occasions, most recent being in March 2011 (Read: Can He Read The Writing on The Wall? Published in B&E issue dated March 31, 2011), just a few weeks before the US federal debt limit was raised to $16.394 trillion. As VAT has a broad base, it could generate enough revenue to deflate the ballooning deficit while simplifying the tax code. Considering that US consumer spending totals some $10 trillion annually, or about 70% of GDP, VAT has the potential to generate big bucks for Uncle Sam. In fact, a Congressional Research Service report suggests that each 1% of VAT has the potential to generate $50 billion. Thus, even if it’s started at a low level, say 5-10%, it can generate big money.
While all of this is doable, it won’t be easy. Not until the President and House Republicans agree to change the current law. And without an agreement on federal fiscal policy, the economy will be in recession by spring. Agreed that threat is expected to spur lawmakers to act, but not before some economic damage is done, we would say!
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