Analysis: U.S. economy would dodge bullet for now under fiscal deal

WASHINGTON Tue Jan 1, 2013 1:30pm IST

U.S. one dollar bills are displayed in this posed photograph in Toronto October 22, 2008. REUTERS/Mark Blinch/Files

U.S. one dollar bills are displayed in this posed photograph in Toronto October 22, 2008.

Credit: Reuters/Mark Blinch/Files

WASHINGTON (Reuters) - A deal worked out by U.S. Senate leaders to avoid the "fiscal cliff," was far from any "grand bargain" of deficit reduction measures.

But if approved by the U.S. House of Representatives, it could help the country steer clear of recession, although enough austerity would remain in place to likely keep the economy growing at a lackluster pace.

The Senate approved a last-minute deal early Tuesday morning to scale back $600 billion in scheduled tax hikes and government spending cuts that economists widely agree would tip the economy into recession.

The deal would hike taxes permanently for household incomes over $450,000 a year, but keep existing lower rates in force for everyone else.

It would make permanent the alternative minimum tax "patch" that was set to expire, protecting middle-income Americans from being taxed as if they were rich.

Scheduled cuts in defense and non-defense spending were simply postponed for two months.

Economists said that if the emerging package were to become law, it would represent at least a temporary reprieve for the economy. "This keeps us out of recession for now," said Menzie Chinn, an economist at the University of Wisconsin-Madison.

The contours of the deal suggest that roughly one-third of the scheduled fiscal tightening could still take place, said Brett Ryan, an economist at Deutsche Bank in New York.

That is in line with what many financial firms on Wall Street and around the world have been expecting, suggesting forecasts for economic growth of around 1.9 percent for 2013 would likely hold.

At midnight Monday, low tax rates enacted under then-President George W. Bush in 2001 and 2003 expired. If the House agrees with the Senate - and there remained considerable doubt on that score - the new rates would be extended retroactively.

Otherwise, together with other planned tax hikes, the average household would pay an estimated $3,500 more in taxes, according to the Tax Policy Center, a Washington think tank. Budget experts expect the economy would take a hit as families cut back on spending.

Provisions in the Senate bill would avoid scheduled cuts to jobless benefits and to payments to doctors under a federal health insurance program.

AUSTERITY'S BITE

Like the consensus of economists from Wall Street and beyond, Deutsche Bank has been forecasting enough fiscal drag to hold back growth to roughly 1.9 percent in 2013. Ryan said the details of the deal appeared to support that forecast.

That would be much better than the 0.5 percent contraction predicted by the Congressional Budget Office if the entirety of the fiscal cliff took hold, but it would fall short of what is needed to quickly heal the labor market, which is still smarting from the 2007-09 recession.

"We continue to anticipate a significant economic slowdown at the start of the year in response to fiscal drag and a contentious fiscal debate," economists at Nomura said in a research note.

In particular, analysts say financial markets are likely to remain on tenterhooks until Congress raises the nation's $16.4 trillion debt ceiling, which the U.S. Treasury confirmed had been reached on Monday.

While the Bush tax cuts would be made permanent for many Americans under the budget deal, a two-year-long payroll tax holiday enacted to give the economy an extra boost would expire. The Tax Policy Center estimates this could push the average household tax bill up by about $700 next year.

The suspension of spending cuts sets up a smaller fiscal cliff later in the year which still could be enough to send the economy into recession, said Chinn.

He warned that ongoing worries about the possibility of recession could keep businesses from investing, which would hinder economic growth.

"You retain the uncertainty," Chinn said.

(Reporting by Jason Lange; Editing by Eric Walsh)

FILED UNDER:
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.

  • Most Popular
  • Most Shared

REUTERS SHOWCASE

Diwali Sales

Diwali Sales

Gold sales jump about 20 pct for Diwali - trade body  Full Article 

World Bank Rival

World Bank Rival

Three major nations absent as China launches W.Bank rival in Asia  Full Article 

Wal-Mart India

Wal-Mart India

Murali Lanka appointed as Wal-Mart India operations chief  Full Article 

Microsoft Earnings

Microsoft Earnings

Microsoft sales beat Street hopes, cloud profits up.  Full Article 

Special Report

Special Report

Why Madrid's poor fear Goldman Sachs and Blackstone  Full Article 

U.S. Economy

U.S. Economy

Spectre of no-inflation world looms over Fed's return to normal  Full Article 

Insider Trading

Insider Trading

Rengan Rajaratnam, SEC to settle civil insider trading charge.  Full Article 

Market Watch

Market Watch

Betting on the beaten up? Investors pin hopes on stocks in Europe, Japan.  Full Article 

India Insight

India Insight

Kalki Koechlin on her role as a disabled girl in “Margarita, With a Straw”  Full Article 

Reuters India Mobile

Reuters India Mobile

Get the latest news on the go. Visit Reuters India on your mobile device.  Full Coverage