US fiscal crisis far from over

The United States avoided going over a “fiscal cliff” on 1 January, but has scripted a new and bigger crisis over the “debt ceiling” in what appears to be a never-ending tug-of-war between President Obama and the Republicans.

by Martin Khor

So, the United States at the last minute averted a “fiscal cliff” crisis, and the world gave a sigh of relief, since the fate of the US economy has strong impact on other countries.

But that sigh was accompanied by a shake of the head at how this drama involving a contest of wills between the President and the Republicans in Congress has become an American way of life.

Have the economy of the US and the rest of the world economy become too dependent on how Washington’s budget politics plays out? It seems so, for some time to come.

From the “fiscal cliff”, there will now be an even bigger fight over government spending. Will it have to be cut? By how much overall? And which items will be cut more, and which will be saved?

The “fiscal deal” was supposed to cover the two issues of tax increases and spending cuts. Only the tax part was agreed to on 1 January by Congress and President Barack Obama.

The tax deal involved raising the top end of income tax rates of the richest 1-2% of Americans and increases in capital gains tax and estate duty. But it also raised by 2 percentage points the payroll taxes that employees pay as part of their salaries towards social security. 

Thus it is not true that only rich Americans are affected by the fiscal deal.  Ordinary American workers have to pay an estimated $113 billion more in payroll taxes.

Nevertheless President Obama and the Democrats are seen to have won a victory because he fulfilled a campaign pledge that richer Americans would have to bear a higher tax burden in the overall effort to reduce the government deficit.

Still, the tax increase is only a small dent on how wealthy Americans have captured most of the gains of economic growth in the past three decades. This rise in inequality led to the grassroots movement of the “99%” fighting for their rights against the 1%.    

With the increase of taxes on the rich, Obama has made his point. And the Republicans, who had vowed that there would be no tax increases at all, have had to give in, though many voted individually against the deal in Congress.

Debt ceiling

However, the bigger part of the social equation is not yet settled. The deal did not cover the spending issue – by how much and what to cut.

The Republicans are cleverly trying to link this to a separate issue of the “debt ceiling.” By law the US administration is allowed to take loans only up to a limit, and the present limit was reached around New Year’s day.

Without Congressional approval to raise this limit, the government would be forced to go into partial default. It would not be able to pay some of its bills or salaries or pensions, or to service its debts.  

For the rest of the world, the most sensitive issue is whether the US could default on its foreign debt. Most countries hold a large part of their foreign reserves in US Treasury bills, notes and bonds; China alone has over a trillion dollars of US debt.

It is unthinkable that the US could default on its debt, but not as unthinkable as before. Last August when Congress postponed to the last day its decision to raise the debt limit, when it bargained with Obama over how much to cut government spending, the credit rating agency Standard & Poor’s downgraded the US’ credit rating from AAA to AA-plus.

The US Treasury is able to use some accounting devices to keep spending for two more months before needing more loans. Thus, between now and March, expect to witness a new President-Congress, Democrat-Republican tug-of-war over spending cuts.

On the broad economic front, economists like Joseph Stiglitz and Paul Krugman argue against overall spending cuts as the weak economy requires fiscal stimulus instead, and there is no harm in increasing the budget deficit in the short term. For them, a drastic spending cut now will unnecessarily plunge the economy into recession. Concerns on the deficit and excessive spending can be dealt with when the economy is strong.

Obama and the Democrats accept that there should be some spending cuts, but want these in sectors such as defence, while shielding welfare and social security benefits from too much cuts, to protect the poor and middle class.

The Republicans, in contrast, want an across-the-board spending cut, including on welfare and social security. They are ideologically for “small government”, boosting the income and interests of the rich (on the theory that they hold the key to investment and growth), and cutting welfare aid and social security subsidies (on grounds that these have burdened society with debt and are a disincentive to people to do their fair share of work).

The budget fights have to do with ideology, but they have both social and economic consequences.

Obama has indicated he is fed up with the Republican strategy of tying the issue of spending cuts to the debt ceiling, saying he will not negotiate with “this Congress” over the debt ceiling. In previous years, raising the debt ceiling was automatic, until Congress used it as leverage last year to make their point over spending cuts.

Now, the Republican leaders are adamant on again using the debt-ceiling leverage to get the size and type of spending cuts they want.

So the world will have to watch the continuing saga of the budget tug-of-war, because what happens in the United States affects the rest of the world.         

Martin Khor is Executive Director of the South Centre, an intergovernmental policy think-tank of developing countries, and former Director of the Third World Network.

Third World Economics, Issue No. 536, 1-15 Jan 2013, pp 2-3