Estimated read time: 6-7 minutes
SALT LAKE CITY — In the months leading up to the 2012 election, a profound sense of uncertainty settled in over the country. Businesses and politicians alike were paralyzed with the idea that it was best to sit tight until the election, because its outcome was uncertain and much was riding on its results.
In a strong sense, many anticipated the election to provide more clarity. After November 6, many commentators and analysts remarked that after billions of dollars spent and a hard fought campaign, the balance of power between parties was largely unchanged. In short, not much changed. Consequently, anticipated clarity never materialized.
Uncertainty at Home
Democrats maintained the White House and Senate, while Republicans retained control of the House. Now, America is depending on the same leaders who brought about 2011's debt ceiling fiasco and subsequent downgrade of the nation's credit, to remedy an even more consequential scenario: the fiscal cliff and another debt ceiling. As a result, the United States is just weeks away from falling into an unnecessary, but guaranteed recession if nothing is done.
In fact, it should be noted that damage to the economy is already being done. Monday's Wall Street Journal reported that, "Half of the nation's 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next ... ." Organizations are cutting back right now and CEOs are growing more pessimistic. The longer it takes to reach a compromise, the more damage will be done — a point Chairman Bernanke made in a speech to the Economic Club of New York yesterday.
In addition to problems at home, uncertainty abroad continues to hang over the global economy. Recent news out of the Middle East, including rocket fire into Israel, continued fighting in Syria and demonstrations in Jordan is making energy markets nervous. Meanwhile, Greece crept back into headlines, with yet another threat of default. New data in Europe confirmed the continent's economic crisis was continuing to worsen and on Monday, Moody's stripped France of its AAA credit rating. All of this clouds the outlook for emerging markets as well, which generally slowed considerably over the last year.
Conflicting SignalsAll of these problems are on-going and familiar to those who follow current events. So, this begs the question: what changed after the election? There are two answers to that question.
First, problems needing to be remedied remain the same. However, the second answer, which should be noted, is that while political leadership and power distribution will be similar to its pre-election construct, the election's passing changed many of the incentives, which fueled gridlock from 2010 to 2012. For example, there's no more time left on the clock, problems either get solved or they don't. Another important consideration: the President isn't running for re-election.
Shortly after the election, Speaker Boehner held a news conference. After the news conference many noted Boehner's conciliatory tone. President Obama's first news conference after the election was also considered to be constructive for compromise. Both leaders spoke of raising revenue without specifically saying that tax rates would have to be a part of that.
However, in the days that followed, positions began to harden again with Speaker Boehner emphasizing that House Republicans could not accept an increase in tax rates, stating additional revenue would have to be raised by closing loopholes.
Treasury Secretary Tim Geithner then stated higher rates on upper-income tax payers would be necessary to address the nation's fiscal issues. President Obama later said the administration's target is to raise an additional $1.6 trillion in revenue over the next 10 years. This figure is significant, because it is roughly twice the size of the deal that the President and Speaker Boehner were close to completing in the summer of 2011; consequently, many wondered if Boehner could agree to twice as much new revenue. However, at a White House meeting last Friday, there was renewed bi-partisan optimism.
The takeaway from recent drama is that there will be twists and turns, but both sides recognize the importance and urgency with which they need to act. There will continue to be both political posturing sending negative signals, coupled with attempts to reassure markets that a deal is achievable. These mixed signals will likely drive near-term market volatility, barring any surprise breakthroughs.
While automatic spending cuts and tax increases are set to take effect on January 1, 2013, it is possible that a deal will not be reached by then. The real deadline for policymakers will be in mid-February, when the nation must confront yet another debt ceiling. The nation's credit rating is on the line; should a default occur after a failure to avert the fiscal cliff, such a scenario would prove to be catastrophic for the U.S. and global economies. However, that thankfully, is a worst-case scenario and will likely be avoided.
What citizens and organizations alike can anticipate is some degree of drag upon the economy as taxes increase and spending is cut as part of short or long-term deal. The question is: to what degree will this occur and will there be offsetting reforms to promote growth?
It should be understood that solutions to the nation's budgetary challenges are known and achievable. How these issues are preferred to be resolved depends on one's politics. However, three things must occur for talks to be considered a success. First, the fiscal cliff must be averted. Second, the nation's long-term finances must be put on a sustainable path in a timely manner, coupled with an increase in the debt ceiling. Third, pro-growth reforms must be implemented.
The widely recognized and praised recommendations from the Bowles-Simpson commission included both more revenue and spending cuts, but also included reductions in marginal tax rates to promote growth. Such an approach maintains a tremendous amount of support and would be beneficial to the overall economic outlook of the U.S.
Key Things to Watch
Both Democrats and Republicans agree that spending must be addressed and even President Obama has talked about entitlement reform. The key sticking points in negotiations will be around revenue.
A key area to watch is talk about tax rates vs. broadening the tax base. Republicans would prefer to raise more revenue by closing loopholes and limiting deductions. While there is ample support in the Democratic Party for raising revenues by limiting deductions, the President ran on raising tax rates for people making $250,000 a year or more. If there is continued talk about tax rates, a deal will likely take longer to achieve. However, if talks stay centered on increasing tax revenue without specific mention of rates, the potential for a timely compromise will rise.
Politicians in the Driver's Seat
Heading toward 2013, one theme that will continue is the idea that politicians are in the economy's driver's seat. At the present time, current challenges require substantive policy responses. Without appropriate policy responses, conditions will continue to deteriorate. However, the opposite is also true. If political leaders in Washington D.C. can put together a credible package, markets will rally, uncertainty will lift and capital will be freed. The result could be a substantial improvement in the economic outlook. All of us should hope they get this right.