February 13, 2013
|Alan Levenson, T. Rowe Price Chief Economist|
While it was a relief at year-end to have an agreement that averted the "fiscal cliff," the debate over U.S. fiscal policy is about to begin again in earnest over the debt ceiling and federal spending. In a sense, the fiscal cliff fix was just part one, the result of which is the American Taxpayer Relief Act of 2012 passed by Congress on January 1.
Still, the fiscal cliff legislation accomplished some useful things:
- It limited the increase in income tax rates to higher income taxpayers, softening the near-term impact on the economy, which we think will still grow around 2.25% in 2013.
- It reduced uncertainty by making most of the tax changes permanent.
- It took a small step in the direction of "structural tax reform"—raising revenue by closing loopholes—in the reinstatement of limits on personal exemptions and tax deductions.
While there may be greater certainty regarding tax rates, there remains much concern over the budget battle looming on spending cuts, as the so-called sequestration requiring some $110 billion in cuts this year was delayed for two months.
The federal government's legal borrowing limit will need to be increased by May for the U.S. to avoid a technical default. Investors may recall that the last battle over the debt ceiling in 2011 (in which the current fiscal warfare is rooted) did not end well, with a downgrade of U.S. debt and a sell-off in some global equity and bond markets and risk assets in general.
- In 2011, Congress agreed to extend the debt ceiling and created a bipartisan "super committee" to put together at least $1.2 trillion of deficit reduction. Failure of the super committee to reach an agreement would trigger automatic spending cuts across the board that would take place at the beginning of 2013.
- The super committee failed to reach a deficit reduction agreement in 2011, but Congress has postponed the automatic spending cuts. This so-called sequestration, or holding back of funds appropriated for government agencies, is now delayed until March 1, 2013. That means sequestration and the debt ceiling are going to potentially overlap, and the federal government will need to negotiate both at about the same time.
While many others may be worried about a repeat of the summer of 2011, or about the possibility that the government would delay paying some of its obligations due to the loss of borrowing authority, I'm less concerned. There are three reasons for a more optimistic view:
- The contingent within Congress that was willing to "play chicken" with technical default is less powerful than it was in the summer of 2011 because of the November 2012 election results. And, because of the message that was sent by the Senate's overwhelming vote in favor of the Taxpayer Relief Act of 2012, there's a need for compromise and a little bit less confrontation.
- The public is increasingly aware of just how silly some of these negotiations are and of how important it is for policymakers to put the country ahead of partisanship. So there's a lot more wrath coming from Main Street into Washington now than there was two years ago.
- Washington recently extended the debt ceiling for three months while each chamber of Congress prepares a budget blueprint for the coming fiscal year. This hints at a climb-down from holding the debt limit hostage to piecemeal spending discipline and perhaps even at a nudge toward a return to long-term budget planning.