U.S. Vice President Biden and Senate Minority leader McConnell
brokered an agreement that was approved by the Senate that seems to
avoid the full fiscal cliff. It now is before the House of
While theJanuary 1 deadline is passed, the more significant one,
we had argued, was January 3, when a new Congress is sworn in. A
failure by the 112th Congress to finalize the legislation would
mean that process would have to begin anew with the 113th
After what is likely tobe an inten se though short debate, the
House of Representatives can either approve the same exact bill the
Senate approved, which would be th e quickest resolution. Or, it
can seek to amend the bill, in which case it must return to the
Senate for their approval. The process could be cumbersome and
require reconciliation and would risk the January 3 de adline.
Alternatively, a majority of the House could fail to ratify the
Senate bill, in which case, it will be up to the next Congress to
claw back from the other side of the cliff.
This sketches the procedural course in the coming days; let's
turn to the substance of the Senate deal. The key highlights
include, a 4.6 percentage point increase (to 39.6%) the marginal
tax rate on those households earning more than $450k ($400k for
individuals), tax deductions. Although credits begin phasing out on
$250k incomes, the dividend and capital gains tax will only be
hiked to 20% (from 15%) on households earning $450k ($400k for
individuals). The payroll savings t ax, which had been reduced by 2
percentage points during the financial crisis, will be restored to
6.2%, which will impact all private sector employees. There was
full-year extension in unemployment compensation. The Alternative
Minimum Tax was permanently indexed for inflation. It delays a 27%
cut in payments to Medicare providers for a year.
One of the reasons w hy this agreement is not a slam dunk in the
House of Representatives, once over the hump of tax increases, is
that there are no spending cuts. Instead, the Senate agreed to
delay for two months the $110 billion in the automatic spending
cuts that were part of the fiscal cliff. Even the $30 billion for
the extension of the unemployment benefits has not been offset with
spending cuts. The idea being that after a cooling-off period,
fresh negotiations will be required to secure spending cuts.
On the other hand, one of the reasons that the Republicans can
approve the bill is that they may still have a trump card: the debt
ceiling. The federal government reached the debt ceiling at the
start of the week, which limits the government's ability to borrow.
The U.S. Treasury has begun taking "extraordinary measures" to
minimize the immediate impact. These maneuverings are not
limitless, but a stopgap for sever al weeks. It appears that an
increase in the debt ceiling is needed by late February or early
March, though creativity of properly incentivized politicians and
bureaucrats should not be underestimated.
We have outlined the procedural process, the substance and
limits of the agreement, now let's briefly sketch out an
1. The capital markets have seemed to have generally looked past
the self-inflicted fiscal cliff debate in the U.S. As we have
noted, fiscal consolidation was not being forced on the U.S. via a
capital strike the way it was in the periphery of Europe. It was
more a political problem than an economic problem. Yet, until the
House of Representatives plays its h and, there may be not big
market reaction. This is also consistent with the thinner market
conditions. The economic data in the coming days features the
monthly PMI readings and U.S. a uto sales and employment report (at
the end of the week).
2. The economic slowdown that the U.S. appears to have
experienced in Q4, which appears to be about half of the 3.1% pace
seen in Q3, seems more a product of inventory draw down, rather
than the uncertainty of the fiscal cliff. Core durable goods orders
rose at a healthy clip in October and November a nd private sector
job growth did not slow. Without going fully off the cliff, we
continue to expect the U.S. econo my to be among the strongest in
the G7 in 2013 with a little more than 2% growth. The ECB and EC
have successfully reduced some of the extreme tail risk in Europe.
China's economy has begun strengthening. These three issues had
been among the chief concerns for investors.
3. We had thought investors would have sense of closure on U.S.
fiscal policy early in the New Year. Now it does not seem likely
until late Q1. In a larger sense, many structural issues that are
needed to ensure the U.S. is on sounder fiscal footing, while at
the same time, addressing the weakness in its physical
infrastructure and ensuring people have skills necessary to
participate in competitive marketplace, have not been
4. Many Republicans will not be happy with the agreement, but
Obama had all the cards. The Democrats have the executive branch
and a majority in the Senate. While the Republicans enjoy a
majority in the House of Representatives, Democrat candidates as a
whole actually received more votes. Moreover the Republicans are
split as the failure of Boehner's Plan B illustrated. Ironically,
the split is very much like in the German Greens. There is a realos
faction that wants to govern. There is a fundos faction that puts
5. The real question is why didn't Obama push his full
advantage? The answer, as we have implied before, on economic
policy, Obama is not very different than some Republicans. Others,
like Bruce Bartlett, an official in the Reagan and Bush I
governments, recognizes this in a piece in the Fiscal Times, '
H ow Democrats became Liberal Republicans.'
None less than Obama himself recognizes this. He explained recently
to an Hispanic audience that he was not a socialist as some of his
critics assert, but rather his economic policies, would have made
him a moderate Republican in the 1980s.
6. One of the great unspoken truths during a debate that seemed
to speak a lot of untruths is that the raising of the taxes on the
wealthy (however defined) is not sufficient to close a $1 trillion
deficit or reduce the America's debt. The driving value was not
fiscal correctness, but a sense of fairness. The concentration of
wealth and income in the U.S. increased during the credit crisis
(and some like ourselves and others, like
Jim Livingston at Rutgers
, see it as a critical
of the crisis) and is increasing in the post-crisis period.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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