US warned of double-dip risk

Posted on August 22, 2012

The stakes in the political stalemate over the US’s looming “fiscal cliff” are rising – with the country facing a much deeper contraction in economic activity early next year than previously estimated.

That was the message from the Congressional Budget Office – a non-partisan agency that calculates the impact of legislation on the finances of the US government – in its semiannual report on the economic and budgetary outlook.

    The CBO said that if Congress takes no action by January 1 – and a series of tax increases and spending cuts take effect as planned under current law – the US economy would be plunged into a double-dip recession, shrinking at a pace of 0.5 per cent in 2013. The unemployment rate would rise from 8.2 per cent in 2012 to 9.1 per cent next year, and 2m fewer US citizens would be holding jobs than under a scenario in which lawmakers agreed to avert the “fiscal cliff”.

    The forecast by the CBO was substantially bleaker than it had been in May, when it projected that the US economy would at least continue to expand in 2013 – albeit at a meagre pace of 0.5 per cent – even if Congress remained paralysed. Doug Elmendorf, director of the CBO, said the change was mostly due to a “reassessment of the underlying strength” of the US economy.

    The CBO warning comes as fiscal policy remains at the heart of the political debate in the US – and at the top of the agenda in the contest for control of the White House pitting Barack Obama, the sitting Democratic president, against Mitt Romney, his Republican challenger.

    The election is being framed by both parties as a stark choice between two visions of the role of government in the economy. This is notwithstanding occasional diversions in to social issues, such as the furore that erupted this week following the contentious comments on abortion by Todd Akin, the Republican Senate candidate from Missouri.

    Broadly speaking, Mr Romney wants to cut taxes and sharply reduce spending in most areas except defence, while Mr Obama wants to raise taxes on the wealthy in order to maintain higher government spending levels.

    Both parties in Congress as well as the presidential candidates have been at odds over budgetary solutions for months, and the stalemate has at times led America to the edge of a full-blown crisis – most notably in August 2011 when the US nearly defaulted on its debt.

    The next critical deadline is January 1, when Bush-era tax cuts expire along with a temporary payroll tax cut – at the same time as “sequestration” kicks in, setting in motion several across-the-board spending cuts to government departments and agencies including the Pentagon.

    According to the CBO, this combination would shrink the US budget deficit from $1.1tn in the current fiscal year, or 7.3 per cent of gross domestic product, to $641bn, or 4 per cent of GDP, in 2013. While this would help the US regain its fiscal footing, the economic consequences would be severe. The US economy would shrink at a rate of 2.9 per cent in the first half, before rising again at a pace of 1.9 per cent in the second half. In May, the CBO had said the US economy would only contract by 1.3 per cent in the first half.

    On Capitol Hill, on Wall Street and across the country, many are counting on the election to break the political logjam, delivering a mandate for lawmakers to move in one direction or the other, with the winners of the poll framing the deal and the losers making some concessions.

    However, there is no guarantee that fiscal gridlock will be eased after the election, especially if voters offer a mixed verdict. And as well as resolving the short-term question of avoiding the fiscal cliff, the US’s long-term budget problems will also have to be tackled in the coming years, amid ballooning costs of health and pension programmes as the population ages. The CBO calculated that indefinitely extending all the tax measures and failing to impose automatic spending cuts would cause the country’s deficits to remain close to $1tn a year for the next decade, putting it on an unsustainable path.

    “The stakes of fiscal policy are very high right now,” said Mr Elmendorf. “We have very serious budget challenges, and very serious economic challenges in this country,” he added.

    But for now, both parties simply seized on the report to validate their positions – with two and a half months left before the November poll. “Today’s CBO report is another indictment of President Obama’s economic policies that have resulted in overspending, increasing debt, and a growing financial burden on the next generation,” said a spokeswoman for the Romney campaign.

    Meanwhile, Jay Carney, the White House press secretary, said: “Republicans in Washington have chosen to double down on the same failed policies that led to the economic crisis in the first place. They’re willing to hold the middle class hostage unless we also give massive new tax cuts to millionaires and billionaires – tax cuts we can’t afford that would do nothing to strengthen the economy.”

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