Former Goldman Sachs Economist Dissects US Fiscal Cliff

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Well, now that we’ve got the presidential election out of the way, time for the serious stuff of fiscal legislation.

Any problem large enough to worry the markets to the same extent as Europe’s debt crisis has to be some sort of problem, and by far the biggest one facing not just the US but the world is America’s “fiscal cliff” — just yesterday, Congress came back together to confront the US deficit.

We are probably tired of hearing the phrase already, but to better understand exactly what is involved and, from that, begin to draw some ideas as to what impact it will have on our businesses, it helps to break down the measures into their constituent parts as ex-Goldman Sachs head of global economics and former adviser to the British Treasury Gavyn Davies does on his blog in the FT.

Mr. Davies explains in layman’s language what is involved. The “cliff” consists of a series of tax and expenditure measures which have already been legislated to take effect on Jan. 1, 2013, and which taken together would tighten fiscal policy by $502 billion in 2013, and $682 billion in 2014 (3.9 percent of GDP).

Legislation has to be amended if this is not going to take place, and therein lies the challenge. A Democratic Senate is focused on avoiding cuts and fixated on the Bush-era tax concessions for the better off, while the Republican House would prefer to see the deficit reduced by making cuts than raising taxes.

Helpfully, the Congressional Budget Office (CBO) has broken down the composition of the fiscal cliff into five main parts as follows, courtesy of Mr. Davies’ blog.

Source: CBO via Financial Times

Focusing on the 2014 figures, cuts in defense (item 1), and Medicare and other government spending (item 2) amount to a modest $112 billion, or 16 percent of the overall tightening. The ending of the Bush tax cuts on lower and middle-income groups (item 3) accounts for a substantial $382 billion, or 56 percent of the total. The Bush tax cuts for upper income groups, which is by far the most politically contentious area, amounts to only $38 billion, or 6 percent of the total.

That leaves $150 billion (22 percent of the total) coming from the ending of the payroll tax cuts, and the emergency unemployment benefits which were agreed upon in 2010.

Mr. Davies goes on to quote the CBO estimates of the economic impact of each of the separate components, expressed in terms of GDP impact (blue bars) and impact on employment (red bars).

Source: CBO via Financial Times

The combined impact would be to reduce GDP by 2.9 percent, tipping the US back into recession, and reducing employment by 3.4 million jobs.

So what can both sides agree on?

Continued in Part Two.


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