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Stepping away from the edge

The fiscal cliff deal won’t make any difference as the US’s finances are structurally unsound, HT writes.

india Updated: Jan 01, 2013 21:43 IST

Cliffs are the leitmotif of the United States political economy. President Barack Obama and Republican senators concluded a last- minute deal to avoid the so-called fiscal cliff — a legislative guillotine of $500 billion in reduced government funds that, it was feared, would tip both the US and the world economy into recession. At the time of going to press, the lower house of Congress is expected, but not certain, to agree to this mix of higher taxes for the rich, extended unemployment benefits and some tinkering of government expenditure hammered out by the two sides in the Senate just before the clock ran out. Global markets will be relieved — for about two months.

For all the political drama surrounding the negotiations, all that has been done is for the can to be kicked down the road. Mr Obama did secure tax rises for the rich and another year of dole for the jobless. This will win him points with his liberal base. But none of this will make any difference to the rising Great American Red Ink Ocean. For example, the taxes on the rich will raise $600 billion over a decade. That sounds impressive until compared with the $11 trillion in debt Washington is projected to accumulate during that same period. Within a few months the Red Ink Ocean will trigger yet another set of fiscal crises. First, the unfinished part of the fiscal cliff — the automatic government expenditure cuts of $110 billion a year — will have to be addressed. Second, Washington will run into a fiscal wall. This will be caused by the US reaching the legislated limit to the amount of debt the government is allowed to accumulate. Last year, the battle over raising the debt ceiling led to another Republican-Democrat stand-off over higher taxes versus lower government spending. There is no reason this will not happen again.

The fundamental problem is that the US government’s finances are structurally unsound. Clinton-era growth rates are unlikely for decades to come. But government expenditure is structured to assume plentiful tax coffers. Mr Obama was right to argue that the rich needed to pay more. But the Republicans are also right to argue the US’s welfare entitlements are unsustainable in the long term. A merger of both arguments would be a sensible way to put the US back on its financial tracks. However, the Republicans are too internally polarised to make such a deal. Mr Obama, on the other hand, seems unwilling to tell his own party some hard fiscal truths. The prognosis is a steady stream of fiscal walls, cliffs and rising tides forced by an ever widening Red Ink Ocean.