Editorial: Diving off the cliff

Last updated 05:00 24/12/2012

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OPINION: The phrase "fiscal cliff" to describe the combined results of tax rises and spending cuts that will automatically start in the United States on January 1 was first used in testimony to the US Congress by the chairman of the Federal Reserve, Ben Bernanke, in February.

The expression had been around earlier but Bernanke appropriated it to concentrate US politicians' minds on the fact that they had created for themselves a device capable of driving a fragile economy over the edge and back into what could be a deep recession. It should have been enough to stir them into action - the US had only barely escaped a re-run of the Great Depression after the global financial crisis and was, and is, chugging only fitfully along.

Nearly a year after Bernanke's testimony, and with only a week to go, the edge of the cliff lies directly ahead with no political agreement on how to avoid it. A compromise proposal put forward last week was shot down by ideologically intransigent Congressional Republicans.

Before President Barack Obama left for a brief holiday in Hawaii last week, he put up another proposal but the thought of getting so close to the brink spooked financial markets around the world as confidence waned that there was sufficient time left for a deal to be hammered out. The dilemma is an entirely self-inflicted one. The steep tax rises and spending cuts that will begin on January 1 were set up as long ago as the middle of last year as a solution to the public debt crisis.

Republican budget hawks in Congress had refused to pass a law that increased the amount of money the US Government was allowed to borrow, the debt ceiling. Without an increase to the debt ceiling the US would have had to default on some of its obligations, a risk that had not arisen since the founding of the republic. In a deal to settle that crisis, the automatic tax rises and spending cuts were passed into law.

It was thought the prospect of the draconian measures would force politicians to moderate their extreme positions.

As it has turned out, that was wildly optimistic and although presidential and congressional elections have happened since in the meantime, the ideological divide in Washington remains as deep as ever. An example is over tax rises.

The president wants them for all those on incomes more than US$250,000, (NZ$303,000) arguing that the rich could and should pay more, the Republicans only for those earning over US$1 million. If no agreement is reached before January 1, the combined effect of the automatic tax rises and spending cuts would sharply reduce the US budget deficit which, according to conventional analysis, would savagely cut US output, some say by as much as 5 per cent. Others query whether it would have such an adverse effect. They point out that the connection between the deficit and output is not clear cut and could even be beneficial.

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Whatever the relative merits of those arcane economic arguments, not many people are happy with the idea of testing them, with all their uncertainties, in a kind of real-time experiment. Political wrangling inside the Washington Beltway is rarely of much interest to the outside world. Another recession in the US, however, would have an impact everywhere.

New Zealand's feeble recovery is particularly susceptible to outside shocks. The risk of one that has been artificially created lends all the more force to the argument for making our own public finances as sound as possible.

- © Fairfax NZ News

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