Counterparties: How to build a safety net for the fiscal cliff

October 2, 2012

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We’re entering a strange time in the politics of the American economy. If Congress doesn’t act by January 1, a series of expiring tax cuts and automatic spending cuts will kick in. This “fiscal cliff” or “taxmageddon”, the CBO says, will send us back into recession and slash GDP.

More specifically, almost 90% of Americans would see their taxes rise by an average of roughly $3,500 per household, according to a report released yesterday by the Tax Policy Center: “Average marginal tax rates would increase by 5 percentage points on labor income, 7 points on capital gains and 20 points on dividends.” Households in the top quintile of income would see their after-tax income fall 7.7%; those in the lowest quintile would see this income would fall 3.7%.

But the NYT reports today that top senators have something resembling a plan. With the threat of a recession looming, the Senate has decided to revisit policies it couldn’t pass last year.

First, there are hints of a possible agreement on a deficit reduction target that seems somewhere near the $4 trillion over a decade that a bipartisan group of lawmakers called for last fall. If that doesn’t work, a second plan would kick in, possibly including Social Security cuts or something like the Simpson-Bowles proposal that was obliterated in the House in May. Paul Krugman is not pleased, calling the possible safety-net cuts “politically stupid as well as a betrayal of the electorate”. And, finally, senators have also come up with a way to delay automatic spending cuts – sequestration, in budget-speak.

Which isn’t to say this will happen before the election: “negotiators will not even try to determine how much money would come from the three components until after the voting.”

Bruce Bartlett, a former Reagan and George H.W. Bush policy staffer, makes the case for patience, suggesting the fiscal cliff is actually more like a steep hill. Bartlett agrees with Peter Orszag and William Gale that the best time for a budget deal is after taxes have risen on Americans:

The virtue of the Orszag-Gale strategy is that it changes the political dynamics. Once taxes have risen on everyone, legislation restoring the status quo ante for all except the wealthy would be scored as a tax cut. While doing this before Dec. 31 would be a violation of the pledge, doing so after Jan. 1 would not.

The problem with this approach is that there’s some evidence that congressional ineptitude has already hurt the US economic mood. Top US CEOs have less confidence in the economy than at any point in the last three years. Gavyn Davies sees signs in August’s economic data that companies are holding off on capital expenditures because of concerns about the fiscal cliff. (Ed Yardeni agrees.) Treasury prices, according to BofA, are already beginning to price in fiscal risks. And all summer, we’ve read more than a few scary features that suggest businesses have started pulling back.

The question, as this analysis from PIMCO suggests, isn’t whether we’re going to fall off the fiscal cliff – it’s just how far we’ll fall. — Ryan McCarthy

And on to today’s links:

Popular Myths
For private equity, “too much is never enough” – Epicurean Dealmaker

Low Expectations
The SEC is only a few decades behind high-frequency-trading technology – Bloomberg

Federal mortgage task force sues JPMorgan over Bear Stearns-era MBS – NYT

Be Afraid
75 former Countrywide execs are once again running a mortgage company – Stephen Gandel

The case against a CEO in the Oval Office – Alan Blinder

Merrill is offering Morgan Stanley brokers $1.5 million to jump ship – WSJ
EU report calls for bank bonuses to be paid in debt – Irish Times
PwC will get paid $1 billion to consult on foreclosure reviews – Francine McKenna

The data do not suggest a recession is imminent – Econobrowser

Bill Gross admits to having a very bad long-term memory – PIMCO

EU Mess
Spain’s banks may need twice the capital that the stress tests show – Bloomberg Businessweek

Right On
The contemptuous, myopic, evil practice of breaking online stories into multiple pages – Farhad Manjoo

And, of course, there are many more links at Counterparties.

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