The Telegraph
Thursday , December 6 , 2012
Since 1st March, 1999
CIMA Gallary

- The US government must act soon to stave off economic crisis

Are Americans doomed to jump over the cliff — the fiscal cliff that is — by the start of the new year? The “fiscal cliff” has become the popular term referring to the catastrophe that may soon strike the American economy, and subsequently the global economy. Unless President Barack Obama and the legislative wing of the American government can come to an agreement before the year comes to an end, new measures will come into effect resulting in tax increases for everyone as well as the withdrawal of several tax breaks for big business. The bad news does not end here because there would also be sizeable reductions in government spending.

At the root of the fiscal cliff or crisis is the American law that the public debt cannot cross a threshold — only the Senate and the House of Representatives can approve an increase in the debt ceiling. The government of the United States of America tried to fight the 2008 recession by huge increases in government spending as well as tax cuts in order to stimulate the economy. While there are signs that these measures have had their desired effects, a harmful side effect has been several years of huge budget deficits. Naturally, the government has had to borrow in order to cover the gap between revenues and expenditure. These successive years of budget deficits took the overall public debt dangerously close to the statutory ceiling.

The government would have had to virtually close shop if the US Congress did not approve an increase in the debt ceiling. This calamity was avoided in 2011 when Congress agreed to increase the debt ceiling, provided steps were taken to increase future tax revenues and decrease government spending in order to reduce budget deficits. The deal between the Congress and Obama took concrete shape in the form of a Budget Control Act. This act, which will come into effect at the midnight of December 31, 2012 will result in the increase of taxes and reduction in public spending.

There is very little debate over the fact that unless agreement is reached to stave off the crisis, the short-term scenario for the American economy is very bleak. Since the economy is just about shrugging off the effects of the recession, the double whammy of tax increases and spending cuts will result in a significant reduction in aggregate demand. A government estimate suggests that if nothing is done to avert the fiscal cliff, then the gross domestic product drop can be as much as 4 per cent, sending the economy back into recession. Two million Americans could lose jobs. And this would happen at a time when social security benefits would also be slashed. The negative impact will, of course, have repercussions on a global economy which is still struggling to keep its head above water. This is why the entire world is watching what happens in Washington with rapt attention. However, while no one wants the Budget Control Act to come into effect with full force at this point of time, everyone also agrees that the US government cannot continue to run such huge budget deficits as the public debt would then approach the levels witnessed in Greece and other beleaguered countries in Europe.

If everyone agrees that there is an urgent need to do something, why is the American economy perched so dangerously close to the edge of the cliff? The answer to this question lies in the highly polarized nature of the American polity. All but a handful of Republicans are proponents of ‘big business and small government’. In popular parlance, they are capitalists with a capital C. They believe that the main reason for the high deficit is profligate government spending and high taxes, the latter apparently responsible for shackling entrepreneurs. “I want to get the government off your backs so that you can work your way out of this mess” was Mitt Romney’s war cry. So, the Republicans prefer relatively low tax rates with lots of exemptions for big business coupled with huge cuts in all kinds of government spending including on social security benefits and Medicare.

The Democrats, on the other hand, are centrists or perhaps even left of centre. (I hasten to add that terms such as leftist and centrist are relative to the local political climate. Most Democrats would be considered to belong to the rabid Right in India.) Obama, for instance, virtually put his presidency on the line in his campaign to ensure that everyone has a right to health insurance. In general, the typical Democratic politician advocates progressive taxation along with adequate spending on social safety nets.

Since the Republicans have a majority in the House of Representatives, any solution must have the approval of the Republicans. But this agreement has so far proved elusive. Obama has declared that taxes will be increased for the top 2 per cent of income earners in the country. He has also proposed only modest cuts in public spending. Not surprisingly, the Republicans have shot down these proposals as non-starters. Both sides are adopting a hard line. Part of this can be explained as bargaining strategy — staring the opposition down. Much of this is also a clash of egos. Matters have not been helped by the fact that the president is a much-hated man amongst most Republicans.

In all probability, an agreement will be thrashed out at the last minute, at least partly because there is scope for compromise. The Republicans have shown willingness to swallow some increase in tax revenue if they come more from rationalization of the tax code rather than through increases in tax rates. Obama will perhaps agree to an increase in the retirement age for Medicaid benefits as well as less generous indexation of social security benefits. Some other somewhat ad hoc agreements will be hammered out and the crisis averted.

But only until the next crisis erupts. In fact, such crises seem an intrinsic part of the American form of government, where the executive powers can possibly rest in a president belonging to one party while the legislative wing is controlled by the other party. Some political scientists claim that the American public deliberately vote in this divided form of government so as to provide appropriate checks and balances on both the major parties. Unfortunately there have been too many instances of confrontation between the legislature and the executive for divided government to be an unmitigated blessing. This needs to be kept in mind by Indian commentators who argue in favour of a presidential system of governance whenever the government seems too unstable in this era of coalition politics.