The Fiscal Cliff? That was easy. Get ready for the Budget Super-Cliff (or Debt Mountain, depending on how far ahead you look)!

09/01/2013 | FxM – Evan Brock Gray

At around 2 a.m. on January 1st, 2013, the U.S. Senate overwhelmingly passed (89-8 votes, 3 abstaining) a bill to narrowly avoid the so called “fiscal cliff” – a moment in which automatic spending cuts and tax increases would have spelt disaster for the U.S. economy. And, after the House of Representatives´ approval (257-167), the bill put an end to more than a year of debate and worry about what to do with the nation´s taxes, spending programmes, budgetary issues and the (soon to be sorely maxed-out) debt ceiling. Or did it…?

The very short-term answer is `yes´. An economist´s answer would be `it depends´. But the general consensus from almost everyone involved and almost everyone who´s been following the negotiations is a clear `NO´.

Even though the bill is considered to be a move in the right direction, “the deal approved…is truly a missed opportunity to do something big to reduce our long term fiscal problems, but it is a small step forward in our efforts to reduce the federal deficit”, said Erskine Bowles, former co-chair of Obama´s National Commission on Fiscal Responsibility and Reform, along with the other co-chair, Alan Simpson, in a joint statement from their newly created group The Campaign to Fix the Debt. However, this bill and last year´s Budget Control Act are “both steps (that) advance the efforts to put our fiscal house in order, neither one nor the combination of the two come close to solving our Nation´s debt and deficit problems” they said.

So, what exactly did the American Taxpayer Relief Act (the official name of the bill, or ATRA) do to stave off the fiscal cliff and what is still left to be done? First, the achievements, shortcomings and failures of the bill will be presented and summarized. Then, the areas that still are in question and the implications for the future budget and U.S. sovereign debt will be set forth.

Achievements (or what the bill actually did):
– Raises about $620 billion in revenue (around $545 billion net after allowing the tax extenders to expire and with bonus depreciation after 2013).
– Reforms some tax laws, such as: individuals making more than $400,000 and families making more than $450,000 per year are moved from a 35% up to a 39.6% income tax rate; capital gains tax rates are increased from 15% to 20% (for those earning in the highest income bracket); estate tax rates are increased from 35% to 40% (for estates valued over $5 million) and the Alternative Minimum tax (ATM) is imposed for the next ten years. There are many other changes as well. (The Journal of Accountancy has produced an article explaining the new tax laws in great detail.)
– Addresses some governmental spending issues, such as: delaying a budget fund sequester, or automatic federal spending cuts, for two months (while setting up incentives to pay for it on its own); imposing a “doc fix” (holding the amount that Medicare pays doctors constant); extending unemployment insurance benefits for a year and extending the farm assistance bill for a year.

Shortcomings (or what the bill didn´t really do):
– It does not permanently fix the problem of rising health costs or an unsustainable (and soon to be insolvent) Social security programme by reforming Medicare and Medicaid spending. Social and personal entitlements are a very politically charged issue for both democrats and republicans and, in the wake of the Affordable Care Act (Obamacare), neither are giving way on this issue.
– There is little reform in this bill that
will stimulate growth and revenue generation in the medium-run.

Failures (or what politicians failed to do):
– The bill does not meaningfully address ways to create a sustainable budget nor does it alleviate medium-term national debt levels compared to gdp (or even stop the national debt level´s increase in the long-run).
– It does not take the current debt ceiling (or debt limit), or the fact that it is about to be irreversibly breached, into account in order to fix this dangerous situation before it starts to affect the international markets, the world-wide economic recovery or even a U.S. default on debts if it is not raised again. Comprehensive, durable and long-term reform on spending, entitlements and budget control will have to wait.

The debt ceiling is really not supposed to be raised, as it was set up that way during the First World War, unless there is political approval. In The Financial Times, an article from the LEX COLUMN makes an interesting point about the debt ceiling´s (officially known as the debt limit) history, what is happening today and what will be happening briefly:
“…Congress has raised it many times (79 since 1960) without too much fanfare. With political division high in 2011, lawmakers realised it could serve as a bargaining chip`. Now Republicans are seeking to extract cost-cuts as payback for the tax raises in the cliff deal, and intend to use the debt ceiling as a level. The cliff deal put the threat of indiscriminate spending cuts off for two months – until just about the same time that the debt ceiling must be raised, setting up another high-stakes battle.”

Defaulting on debt obligations would be disastrous for the world´s top economy, for the world economy in general and would also set the wrong kind of precedent that other countries might follow (“hey, if they did it, why can´t we?”). The $16.4 trillion debt ceiling was hit on January 1st, only to be averted for another two months. This, along with the fact that “the government´s budget authority runs out on March 27th”, means that not only could there be a default on debt but “without a deal, there could be a government shutdown”, according to Shahien Nasiripour and Tom Burgis of The Financial Times.

However, not controlling the debt now or in the future would also have undesirable consequences like: `extraordinary´ actions by the Department of Treasury which have already started (described below); a large decrease in domestic and foreign investment; a raise in interest rates to attract investment but that would mean greater costs for the government and slower economic growth; a decrease in confidence levels and even another downgrade in the U.S. credit rating by ratings agencies; preferential payments and the political fall-out over who gets what and when; not being able to meet domestic obligations like contributing to healthcare programmes, funding schools or paying federal employees and, lastly, a severe debt and economic crisis.

According to The Committee for a Responsible Federal Budget (or CRFD) which is a bipartisan, non-profit organization in the United States committed to educating the public about issues that have significant fiscal policy impact and is headed by Maya McGuineas (Harvard University):
“Policymakers must include along with this (the debt ceiling) a set of measures which will substantially improve our medium and long-term fiscal position – preferably enough to bring the debt down to 60 per cent of gdp over the decade and stabilize it below that level. Any long-term increase in the debt ceiling should be conditional on the inclusion of such measures”.

U.S. national public debt today is more t
han $11.57 trillion and governmental debt holdings are more than $4.85 trillion. As a percentage of gdp ($15.974 trillion is forecast for the beginning of 2013), public debt would stand at around 72.5 per cent, roughly the same percentage that is expected a decade from now according to the CRFD. Falling off the “fiscal cliff” might have put U.S. sovereign debt levels below the 60 per cent of gdp goal by 2020, but the economic consequences would not have been pretty nor are easy to project. The outgoing Treasury Secretary Timothy Geithner says there is only about $200 billion available by taking these “extraordinary” measures (like tapping the federal employees´ retirement fund, the Exchange Stabilisation Fund, the Civil Service or Postal Funds or maybe even allowing mature securities from these last two funds to be used). The timeline before the U.S.´s cash-on-hand and extraordinary measure funds run out is estimated to be sometime between February 15th and March 1st of this year. After that, the Treasury would have a very difficult time facing up to its obligations and liabilities.

taxes, spending, budgets and the national debt ceiling are the biggest issues on the U.S. government´s plate right now. Since it seems that the first issue was “settled” with the ATRA from the “fiscal cliff” deal, the other three areas are about to take centre stage. If you thought the “fiscal cliff” negotiations were tense and last-minute, get ready for the “budget super-cliff” and “debt mountain” because they are right around the corner and even more important.