Compromise can save Obama from the fiscal cliff

“We’re not as cynical as the pundits believe,” proclaimed President Obama last Wednesday. “We are greater than the sum of our individual ambitions”. When it comes to post-election oratory, few can match the 44th President. Hoarse, even broken-voiced, after months of campaigning and the final desperate push, the most powerful person on earth basked in the adoration of supporters in Chicago, as they reveled in his re-election.

As the crowd’s roar hit fever pitch, Obama’s rhetoric soared, his final sound-bite fitting snugly into TV news bulletins across the globe, precisely as was intended. “We remain more than a collection of red states and blue states,” the re-confirmed President thundered. “We are, and forever will be, the United States of America”.

Whatever Obama says, though, last week’s election returned a deeply divided US ruling class to Washington. The Democrat candidate is still in the White House, but no single party has anything like meaningful control. The economic management of the world’s biggest economy will now stand or fall on compromise. Unfortunately, the outlook for compromise doesn’t look too ood.

It has been widely stated, not least in the UK, that Obama beat Romney in a “decisive” manner. He did nothing of the sort. As America’s election night unfolded, it’s true that most of the “swing states” – the likes of Ohio and Virginia – went to Obama, so he pulled ahead in terms of the electoral college. With 50 or 51 states declared (Florida remains contested, it’s always Florida!), Obama has a commanding 303 electoral votes, with Romney on 206.

Yet Obama won almost every battleground state on a wafer-thin margin. So the President’s 50.4pc share of votes cast was barely ahead of the 48pc polled by his Republican rival. While there was no repeat of the Bush/Gore debacle of the 2000 election, when the overall result hinged on a prolonged and grotesque legal battle, Obama’s victory was a very long way from a landslide.

When last Tuesday’s Congressional voting is also considered, America’s political leadership remains split almost precisely down the middle. The Democrats hold the White House and the Senate, but the Republicans control the all-important House of Representatives. So, despite the President’s victory cry, the US is far from “united”. The only winner last week was gridlock.

The big question now, of course, is the extent to which America – and in turn the broader world economy – will now be high-jacked by uncertainties relating the resolution of America’s tortured budget. Global markets have switched their focus, laser-like, from the US election to the “fiscal cliff”.

The conundrum, by now, is well-known. Unless a deal is reached between America’s various law-making institutions by the end of this calendar year, a mix of $650bn (£409bn) in spending cuts and tax increases will automatically kick-in. This amounts to a significant fiscal retrenchment, provoking warnings that, if the two sides don’t compromise, America will tip back into recession.

The International Monetary Fund, no less, last week said that going over the cliff “would have large international spillovers”. It was the indecisive nature of Obama’s victory, and the resulting gridlock potential, that caused the bellwether S&P 500 index of US stocks to fall 3.6pc since the result was declared.

All tax and spending legislation is initiated in the House of Representatives, where the Republicans now control 238 votes, compared to 197 for the Democrats. House Republicans have been insisting for months that spending cuts should be used to rein-in the US deficit, not higher taxes. Having campaigned on such a platform, the Republicans still hold almost the same numbers of seats now as they did before this election.

So House Speaker, John Boehner of Ohio, insists that “there is no mandate for raising taxes”. This reflects the concern of his felloe Republicans that, while deficit-reduction is crucial, tax rises would stymie growth. This is in stark contrast to Democrats in both the House and Senate who, together with their President, most definitely want higher taxes. To be sure, America’s political gridlock reflects a deep ideological divide. This will be extremely tricky to resolve, given that the chamber in which the budget will first be proposed has a majority that disagrees with the Senate and the President.

Taking the three main elements of the “fiscal cliff” in turn, there is likely to be agreement on allowing temporary payroll tax breaks to expire. There could also be a compromise on $110bn of spending cuts due for 2013 to be pushed further into the future. After all, half the scheduled cuts apply to defence and cutting that sector can offend even the most fiscally conservative Republicans.

The flash-point will no doubt be the “Bush tax cuts” – a complicated mesh of income tax reductions introduced in 2001 and 2003 that expire in January. There are some aspects of this upcoming repeal that Democrats don’t want, like a reduction in childcare tax credits and an elimination of college tuition subsidies. The Senate and the White House could well insist, though, that scheduled tax rises on dividends and capital gains are most definitely implemented.

The Democrats are also adamant that households with incomes above $250,000 pay more – a move that, more than anything else, makes Republican bluebloods see red. Since gaining re-election, Obama has singled out “higher taxes on the rich” as a condition of any budget agreement. This may be an opening gambit, but we’re clearly in for a hard-fought battle which, for the rest of the year and beyond, will keep financial markets on edge.

If the politicians can’t agree, driving the economy over the fiscal cliff could well see unemployment rise towards 10pc, from 7.8pc now. On top of that, gridlock, and the resulting failure to produce a budget, will see the government hit its debt ceiling in about early February if nothing is done, raising the frightening spectre of default.

The bigger issue over the next four years, though beyond the partisan “fiscal cliff” struggles, is whether America achieves some kind of meaningful budgetary retrenchment. The US annual budget deficit has almost tripled under Obama, from $450bn in 2008 to $1,100bn this year. The national debt is now perilously close to its $16,400bn limit, two-third higher than when Obama was elected.

In 2008, US government debt was 70pc of GDP. Now it is 102pc. The last time it was this high was in the aftermath of World War Two. Back then, America was a nation in its zenith, about to embark on a population boom and a multi-year run of growth and rampant economic development. America today is an ageing society, weighed down with liabilities stretching years into the future.

For above and beyond the impending fiscal shenanigans, there is no sign whatsoever of any political agreement on how to reform old-age benefits so as to prevent the derailment of Uncle Sam’s finances over the coming decades as tens of millions of those baby-boomers retire.

Some want Obama to use the political leverage he has gained from re-election to raise taxes and lock-in higher benefits. The real leverage the President has, in his second and final term, is that he doesn’t need to worry about re-election. That’s why Obama should offer the Republicans a deal to rein-in his country’s ballooning entitlement spending before it spirals completely out of control. Only then will he give America the “hope” he so eloquently offered at the start of his Presidency.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: