US steers clear of fiscal cliff

American politicians peered into the abyss on New Year’s Day, stepped back, and struck a deal. But they’ll be back on the edge soon.
U.S. Senator John Barrasso (R-WY) (L) and Senator Brian Schatz (D-HI) (R) chat about the time as .../ Credits: Reuters
Taxes are raised on the wealthiest, spending cuts postponed, under the last-minute compromise legislation passed by the U.S. Congress on New Year’s Day that averts, for the time being, hundreds of billions of dollars worth of automatic tax rises and spending cuts that were due to come into effect from January 2013.

Many believe that these measures would have tipped America back into recession with calamitous effects for the world economy and global markets. Instead, American lawmakers have bought some time. Global markets breathed a huge sigh of relief on January 2, rallying across the board.

Brokered by Senators Joe Biden (D) and Mitch McConnell (R), the “Taxpayer Relief Act” introduced the following key tax measures:

- Tax cuts introduced by George W. Bush will expire for people earning over 400,000 dollars a year, and families earning more than 450,000 dollars, increasing their income tax rate from 35 to 39.6 percent.

- A permanent increase in taxes on capital gains and dividends from roughly 15 per cent to 20 per cent for the same high earners as above.

- Increased Estate Tax on inheritances from 35 to 40 percent for estates worth over five million dollars, although that threshold will be adjusted annually for inflation.

- Phasing out of personal exemptions and itemized deductions for couples earning more than 250,000 a year and single people earning more than 200,000 dollars.

All told, the White House estimates that the new tax measures will raise an additional 600 billion dollars in the coming decade.

The agreement “would further reduce the deficit by asking the wealthiest 2 percent of Americans to pay higher taxes for the first time in two decades...So that’s progress,” President Obama said in a statement. He had originally hoped to bring all of that 2 percent—households earning over 250,000 dollars annually—into the top tax bracket in order to at least double the 600 billion dollar figure, but was forced to compromise.

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At the same time, the two sides agreed to allow the “payroll tax holiday” to expire, meaning that an extra 2 percent will be taken from Americans’ pay checks to pay for Social Security. The rate goes up from 4.2 percent to 6.2 percent.

They also extended Bush-era income tax cuts for the vast majority of American households, 2009 tax breaks for low-income Americans for another five years, business tax breaks for research and investment for another year, and federal unemployment insurance for the long-term unemployed through 2013.

Meanwhile, the spending cuts that were due to be enforced from the start of this year, and which many feared would tip the U.S. back into recession, have been postponed until March, as had a decision on what do do about them.

And so the debate will continue, particularly on the question of how to raise the United States’ official debt ceiling, which now stands at 16.4 trillion dollars and was officially reached on December 31. Republicans will argue for cuts in entitlement programs such as Medicare and Social Security in return for a rise in the debt ceiling.

In general, commentators seemed relieved but disappointed that the political process delivered such a modest result. Many argued that this deal is far from the “grand bargain” of tax increases, spending cuts, and welfare reforms that are really needed to put the U.S. economy on a fiscally sustainable footing for the long term.

Michael Feroli, chief U.S. economist at J.P. Morgan Chase, commented in the Washington Post: “What’s challenging is that we’re still going to have some slowing in growth because of the tax hikes...What’s not good is that deficits are still going to be large and it doesn’t begin to touch the longer-term horizon.” He estimated that the deal will cut U.S. economic growth by 1 percent.

On New Year’s Eve, writing for CNBC, PIMCO CEO Mohamed El-Erian had described the likely outcome of last ditch talks as a “micro deal” and “a temporary Band Aid”.

“Within a few weeks, we would again witness high-stakes drama in Washington, this time in the context of negotiations to increase the debt ceiling. Meanwhile, most Americans would resume their frustratingly long wait for the economy to heal,” he said. This high-stakes drama is far from over.

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