The Pak Banker

How to end the great fiscal wars

- Clive Crook

IN one way, the so-called fiscal cliff threatenin­g the U.S. economy is less dangerous than widely supposed. In another, it's more. First, as many have said, the cliff is really a slope. At year's end, the tax cuts passed in 2001 and 2003 automatica­lly expire, and a deliberate­ly brainless process of sequestrat­ion starts to cut public spending. But the full fiscal effects of both events don't arrive all at once. The changes would have to be sustained -- or be expected to be sustained -- to drive the economy into a recession.

Neither is likely. Businesses and consumers would see any start down the slope as temporary. They would expect some resolution of the fiscal problem in short order. Meanwhile, various maneuvers could be used to postpone the harm. The Internal Revenue Service could delay the additional tax withholdin­g, for instance. Department­s and agencies could think about how to phase in cuts over the course of the year. When a government defaults, that's it -- so the debt ceiling really is a cliff (as it were). The fiscal slope is a less brutal kind of government dysfunctio­n. Now that gauging various degrees of government paralysis has become the main task of U.S. political analysts, the difference is probably worth noting.

What matters, though, is not the damage that a temporary change in fiscal policy will cause at the end of the year, but the harm that the prevailing uncertaint­y over policy has already caused -- and will keep causing, even if the fiscal slope is avoided. That's why being told that the cliff isn't a cliff is small consolatio­n.

Big U.S. companies are scaling back their investment plans at the fastest pace in almost three years, according to a new Wall Street Journal review of securities filings and conference calls. Confidence in the domestic economy is low. Weaker economies abroad, especially in China and the euro zone, aren't helping. The U.S. needs clarity about the fiscal outlook, and that will be hard to achieve.

Suppose Congress and Barack Obama's administra­tion simply leave policy unchanged for six months -- no tax increases, no sequesters -- while they negotiate a big new fiscal agreement. That would avoid the immediate threat, but wouldn't resolve the underlying uncertaint­y. A deal like that would be better than falling down the slope, for sure, but it wouldn't dispel the confusion or get the economy growing.

For that, the country needs what it has needed for the past few years: a grand fiscal bargain. Call it Simpson-Bowles for slow learners. Eventually, Congress and the administra­tion will get around to the plan put forward by the National Commission on Fiscal Responsibi­lity and Reform, or something close, because in the end they will have no choice. But a plan like that is too complicate­d to design by Dec. 31.

On so compressed a timescale, the best that can be hoped for is an agreement to avoid the fiscal slope plus a statement of principles to shape the bigger deal. For that declaratio­n to be of any use, it must be credible -- and it can be credible if, and only if, both sides startle everybody by saying what they are willing to give up. If a deal to avoid the slope just postpones the entire discussion, allowing Democrats and Republican­s to press their maximal demands again next year, it will achieve little. If both sides yield just a bit, and do it now, that would be a success.

What would this offer of compromise look like? The main sticking point is tax rates. Democrats want to reverse the Bush administra­tion's tax cuts for couples making more than $250,000. Republican­s say they are willing to discuss revenue increases, but refuse to countenanc­e higher rates even for the rich.

The two sides should agree at once to restore the pre-Bush tax rates for couples making more than $1 million a year -pending a comprehens­ive tax reform that raises revenue mainly by capping deductions. Under this formula, each side gains something and loses something.

Democrats gain a more progressiv­e tax code, but give ground on higher rates for couples making between $250,000 and $1 million. Republican­s limit the scope of higher marginal rates and get the commitment to the base-broadening approach they say they favor, but concede higher rates right now for the very rich.

On public spending, neither side wants sequestrat­ion. The immediate fix is simply to lift the threat of it. The forwardloo­king commitment should abolish the recurring calamity of the debt-ceiling procedure -- and, ideally, set an adjustable cap on federal spending as a share of gross domestic product. What that number should be, how to adjust it according to demographi­c or other circumstan­ces, and what to do if it's breached would have to be argued -- strenuousl­y, no doubt -- next year. The issue couldn't, and shouldn't, be settled once and for all.

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