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A bad cliffhanger

Congress and the President went past its own deadline of midnight on December 31st, but a day later reached a deal on the so-called “fiscal cliff”. With its vote late on Tuesday night, the House of Representatives joined the Senate in approving legislation that will avoid tax increases for most Americans and scheduled cuts in defense and other government programs. This is less a resolution of the fiscal cliff than its postponement for two months, when the issue of spending cuts, along with approval of raising the debt ceiling, will need to be addressed. It’s like sitting through a bad movie that you couldn’t wait to be over, only to learn there isn’t a conclusion, because they are making a sequel.

Taxes were planned to rise for all, due to the expiration of the tax cuts instituted under President George W. Bush. But under the new deal, taxes will increase only on those with incomes of more than $400,000 ($450,000 for couples), which is about 2 per cent of the population. While the issue of taxes were resolved, the spending side of the equation was not: the scheduled cuts (referred to as a “sequester”) were postponed, and there were no further spending cuts introduced.

The compromise reached indicates that the two parties are not serious about addressing growing deficits (see my earlier post). According to estimates from the Congressional Budget Office, the deal will add almost $4 trillion in debt over the next 10 years.

Politically, it appears that the Republicans are the losers, as they voted for a tax increase (which is anathema to their stated ideology), and did not receive any of their desired spending cuts in return. President Obama had boxed them into a corner, as they did not want to be seen as blocking a reduction in taxes for 98 percent of Americans.

Conversely, it appears that Obama and the Democrats won, as they were able to get approval for a tax rise on the higher earners and thus fulfill their campaign pledge for tax “fairness”. But it’s not that straightforward. By doing a separate deal on taxes alone, the Democrats seem to confirm the broader impression that they have no desire to cut spending and rein in deficits. Moreover, with this deal they have made the Bush tax cuts permanent for those below the $400,000 income level – the same tax cuts that Democrats have criticized as irresponsible and the root of all fiscal problems for the past decade. It is next to impossible to fund the level of spending that the Democrats desire, especially with the retirement provisions of Social Security and Medicare, without broadening the tax base.

Meanwhile, we have Fiscal Cliff 2 to look forward to. American politicians like to mock the political conflict and stagnation in countries like Greece and Italy, but the spectacle in the US is just as unedifying. With all of the objective problems of the US economy, it is saying something that the number one obstacle to economic progress is the shenanigans of the American political class.

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