After last year's debt ceiling shakedown, which lasted most of the year, it is hard to imagine that Congress will strike a compromise to forestall the "Fiscal Cliff" facing us at the end of this year.
The many impacts of sequestration on the municipal market through cuts in Build America bond subsidies, reductions in funding for air traffic controllers, and surface transportation cuts are being discussed with higher probabilities attached.
Absent any magic before the pre-election recess, the budget and tax negotiations will be taking place in the aftermath of a bruising national election and during the short Congressional session before the holidays. That suggests a degree of cooperation and compromise that we have not seen in a long time.
Last year's political melodrama was a revelation in how entrenched the political battle lines have become and the lengths to which the political parties will go to seek advantage over the other. This election will likely not change any of that.
The fiscal cliff, however, is a slightly different cat than the debt ceiling (which will raise its head once again early in 2013). The US Treasury cannot function without an increase in its capacity to borrow, which would force a federal government shutdown. The same is not true of the fiscal cliff.
The Office of Management and Budget (OMB) has warned of negative consequences — a shallow half-year recession — but the nation would continue to be able to pay its bills, issue bonds, and function. Raising the debt ceiling is not optional, resolving the fiscal cliff, however, is.
The fiscal cliff is a calamity of our own making that can be avoided if Congress chooses. It is worth considering whether the fiscal cliff, in fact, should be avoided. Like Thelma and Louise in the 1991 Ridley Scott film of the same name, maybe the nation should hit the gas pedal of our 1966 Ford Thunderbird and drive over the fiscal cliff without looking back. This would have several beneficial effects.
First, it would put the nation solidly on the fast track to fiscal recovery, with immediate and substantial progress on the deficit. The improved footings of the federal government would boost investor confidence in state and local credit quality which is sorely needed right now. Congress would not be able to make this much progress in ten years or more.
Secondly, with the "right-sizing" of the deficit, it would give Congress the time to fight over the more detailed aspects of tax and budgetary policy with the certainty that the budget is back on a sustainable path.
Finally, with this bold strategy, we could be the first major developed nation to resolve its debt problem, leaving us in an enviable enhanced leadership position in the global economy.
The Thelma and Louise approach does have a major drawback. The recovery is fragile and the OMB estimates that the combined result of higher taxes and lower spending would cause a two-quarter contraction in GDP and a full year decline of 0.5%. This would hurt state finances just as they are finally beginning to stabilize. The unemployment rate, under that scenario, would rise to 9.1%, leading to more unemployment compensations claims at the state level, and perhaps more borrowing. If the OMB is correct on its forecast, the human cost is too high to tolerate.
There is, however, a sound strategy to ameliorate the pain advocated by Bill Gale of the Brookings Institution: pass a payroll tax reduction to stimulate the economy and offset the macroeconomic impact of the sharp reduction in the budget. We have already seen that a payroll tax reduction is effective in boosting spending and promoting increased economic activity. We know that resolving our fiscal problems is a necessary pre-condition to any possible resumption of the stronger trend growth the US historically has enjoyed. It sounds too good to be true.
And it is. The fly in the ointment is that the payroll tax would require the same Congress that is resolute in its desire to create doomsday scenarios to pass the needed payroll tax legislation. This would make the fiscal cliff less dangerous, which is not what Congress wants. Congress will not voluntarily disarm itself. If we end up going over the fiscal cliff, it will be just like in the Thelma and Louise movie, with a reckless refusal to compromise and the certainty of a very unpleasant landing.
Chris Mier is the Chief Strategist and director of the
Loop Capital Markets Analytical Services Division.