Although the United States has averted insolvency in a last-minute deal, a US analyst says it's only postponing a worse standoff for later. But he thinks deep structural reforms are required for a truly balanced budget.
DW: What do you make of the deal reached by the American Senate?
Jacob Funk Kirkegaard: I would call it a tactical victory for President Obama, if you look at the way the deal is structured. I mean, it's $600-plus billion in new tax increases, and very little cost cutting.
At the same time you have - on the assumption that the House will pass it - a pretty historic bipartisan commitment from a very large number of Republican senators for significant tax increases, both for high income households - above $400,000 for individuals and $450,000 for households - but also one that's more economically important: the 2 percent payroll taxation increase. So, all in all, a very significant increase in taxes for all Americans, in fact.
And on top of that, the Democrats also got through the extension of the unemployment benefits, and an extension of the earned income tax credits. So I would say that by and large the White House got what it wanted in the short run.
What didn't it get?
What it didn't get - and this is the major caveat - [is] a deal on the debt ceiling. That deal will have to be reached over the next couple of months, and there's no doubt that part of the reason that the Republicans, particularly in the Senate, decided to agree to all these tax increases is that now they feel that what was President Obama's biggest political advantage, namely this idea that the Republicans were blocking, were willing to go over the fiscal cliff to protect tax breaks for millionaires - that political advantage has now disappeared, because the Republicans, the outgoing Congress has basically accepted these tax increases.
Which means that President Obama - at least, that's the hope of the Republicans - will have considerably less political leverage in February when you have to reach a deal over the debt ceiling. And it's very clear, when you look at the design of the Senate deal, which is 95 percent tax increases, that the Republicans come February will be looking for something that is overwhelmingly spending cuts. So they have essentially swallowed hard and prepared for a bigger fight in a couple of months, when they feel they have a better position.
So I would call it a tactical victory for President Obama, but really only postponing what I think will be an even more high-wire act. Basically, the US went over the fiscal cliff and not much happened, frankly, with a few hours. But if you go over a debt ceiling then you have a default, which is an altogether different and cataclysmic event.
The pressure and the potential market effects in February will actually be considerably higher than they are today. So I think we should stand by for another, potentially worse stand-off in a couple of months.
The bill is now going to the House of Representatives. Are they likely to reject it?
Kirkegaard said a tenser standoff is in the making
I think that they will accept it. The vast majority of Democrats in the House will accept it, and therefore you don't need more than 30 or 40 Republicans to vote for it to get a majority, which I predict they will do.
I would expect a significant number of House Republicans to vote against it; but politically I would expect John Boehnor to have a simple vote about this and then basically blame it all on the Senate - you know: we didn't have a choice, the clock was ticking, et cetera, et cetera. But certainly this is going to be important, because if a very large number of Republicans in the House vote against this, then I think we can expect even tougher negotiations in February.
I can't imagine that many members of the new House of Representatives will want to vote for anything that has further tax increases in February, and President Obama has already said that he expects any future deal also to be "balanced" in nature. Which means that it is not likely that the Democrats will accept a deal over the debt ceiling that is overwhelmingly focused on spending cuts - but they also want more revenue again in February. So it's going to be worth watching how many House Republicans vote against [this].
Where is the US going to find money to reduce its deficit? If it doesn't want to increase taxes or cut spending, where is it going to get the money?
Reflecting that President Obama won the election and the Democrats kept control of the Senate, I would expect most of the short-term holes to be reduced, the budget deficit will be reduced, by increasing taxes. But that certainly will not balance the US federal budget. It will merely reduce the deficit from where it is now, which is sort of in the 5 to 7 percent range, down to perhaps 4. It will not achieve any degree of long-term sustainability of the US fiscal situation. Because for that to be achieved, you need to have much deeper reforms, not least of healthcare costs, but also social security, and the overall tax system in the United States.
The one major reduction in spending that will come is really a result not so much of a desire from either the Democrats or the Republicans to save money. But the fact that President Obama has signaled very clearly that he's going to pull out of Afghanistan in 2014 means that the US will be cutting its defense budget significantly, simply because the wars in Afghanistan and Iraq will be over.
So there are significant savings there. But beyond that I think it will be extremely difficult, without much broader reforms of the entitlement systems, to achieve anything that remotely approaches fiscal sustainability in the United States.
So you can say that what happened with this deal over the fiscal cliff was a very small down payment on what will be a much longer-term and much broader-based and multi-year effort to achieve fiscal sustainability in the United States.
Jacob Funk Kirkegaard is a senior research fellow at the Peterson Institute for International Economics in Washington. He is also a senior associate at the Rhodium Group, a New York-based research firm, where he leads its analysis of advanced economies.
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