Up and Down Wall Street
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WEDNESDAY, MARCH 21, 2012
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.Can the U.S. Road Runner Avoid the Fiscal Cliff?
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.By RANDALL W. FORSYTH
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.The present path leads to renewed recession. But there's hope in Fed policy and possible compromise.
"We're too big and powerful for anything bad to happen to us." That might be
the famous last words of the captain of the Titanic but it also would be an apt
description of Congress's stance as a fiscal iceberg looms dead ahead.
Huge tax increases and draconian spending cuts will take effect next January unless Congress does something about it. And prominent economists from both sides of the political spectrum are warning of the dire impact on the economy. If Congress fiddles, as it is wont to do in an election year, the economy will go up in smoke.
House Budget Committee Chairman Paul Ryan, a Wisconsin Republican, presented a GOP budget Tuesday that would cut taxes by setting brackets of 10% and 25% and eliminating many tax preferences. As admirable as the methods and aims of the plan, it has a snowflake's chance of survival in the 70-degree warmth of the Northeast. Absent Congressional action, taxes rise and spending plunges, with potentially disastrous effects.
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Former Federal Reserve Vice Chairman Alan Blinder sounded the alarm at the "fiscal cliff" the U.S. seems headed for in an op-ed article in Monday's Wall Street Journal. Blinder is a Keynesian Democrat appointed to the central bank by Bill Clinton, and a professor in the economics department at Princeton University, which formerly was chaired by none other than Ben Bernanke, the present Fed head.
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A similar tocsin was set off by Martin Feldstein in Tuesday's Financial Times. Feldstein is a Harvard professor who headed Ronald Reagan's Council of Economic Advisors and a long-time Republican economic commentator and adviser.
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Both Blinder and Feldstein concluded that the fiscal path on which Congress has placed the U.S. is a road to economic ruin. Because of past decisions -- or lack thereof -- the Bush tax rates are set to expire, the payroll tax cuts will end and unemployment benefits will be curbed on Jan. 1, Blinder points out. And last summer's debt ceiling fiasco ordained $1.2 trillion in spending cuts because the less-than-Super Committee failed to trim $1.5 trillion in deficits over 10 years, he adds.
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Feldstein calculates a tax increase of $512 billion in 2013 is equivalent to 1.9% of gross domestic product and would raise the federal government's take to 18.7% of GDP from 15.8%. Revenue as a percentage of GDP would increase to 19.8% in 2014 and remain over 20% for the rest of the decade.
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"A sustained tax increase of that magnitude would push the U.S. into a new and deep recession next year," Feldstein concludes.
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Blinder and Feldstein agree Congress must act to prevent this Road Runner-like hurtle off the fiscal cliff. Nothing is likely to get done during the election campaign. That leaves only the lame-duck session at year-end as the window of opportunity.
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The political futures markets such as Intrade.com currently suggest President Obama will win a second term while the Republicans will capture the Senate as well as the House of Representatives, making for a completely divided Washington next year. "While neither party would want to see the economic downturn that would result from failure to achieve a compromise, accidents do happen," Feldstein observes.
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Michael T. Darda, chief economist and market strategist for MKM Partners, is less pessimistic. Some sensible compromise with a "Simpson-Bowles feel to it (base broadening to raise revenue, rate streamlining to limit the economic fallout on incentives and the economy)" could be in prospect.
Fiscal concerns could produce for the stock market "a multi-month consolidation starting in the fall until policy uncertainty begins to lift," he writes, but that history doesn't show equities will suffer if tax rates rise.
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In the 10 episodes in which income-tax rates increased in the last century, stocks rose in six instances and fell in four, Darda finds. In the year before tax hikes, stocks rose in seven instances and fell in three. The average rise in the Standard & Poor's 500 in the 10 periods income-tax rates rose was 5.5%, while the average rise in the year before was 6.5%.
."This suggests that other forces (monetary policy, the health of the commercial-banking system, credit markets, the business cycle) were likely more important to market performance. Moreover, many of tax hikes in our sample were associated with wars, when the public's tolerance for tax hikes would be higher."
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To be sure, Darda concludes that "supply-side shifts" cannot be offset with "easier money." That's unlikely, he writes, given the compromises required in a divided government. Indeed, that would be a formula for stagflation. But, as Feldstein reminds, accidents do happen.
Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved
Huge tax increases and draconian spending cuts will take effect next January unless Congress does something about it. And prominent economists from both sides of the political spectrum are warning of the dire impact on the economy. If Congress fiddles, as it is wont to do in an election year, the economy will go up in smoke.
House Budget Committee Chairman Paul Ryan, a Wisconsin Republican, presented a GOP budget Tuesday that would cut taxes by setting brackets of 10% and 25% and eliminating many tax preferences. As admirable as the methods and aims of the plan, it has a snowflake's chance of survival in the 70-degree warmth of the Northeast. Absent Congressional action, taxes rise and spending plunges, with potentially disastrous effects.
.
Former Federal Reserve Vice Chairman Alan Blinder sounded the alarm at the "fiscal cliff" the U.S. seems headed for in an op-ed article in Monday's Wall Street Journal. Blinder is a Keynesian Democrat appointed to the central bank by Bill Clinton, and a professor in the economics department at Princeton University, which formerly was chaired by none other than Ben Bernanke, the present Fed head.
.
A similar tocsin was set off by Martin Feldstein in Tuesday's Financial Times. Feldstein is a Harvard professor who headed Ronald Reagan's Council of Economic Advisors and a long-time Republican economic commentator and adviser.
.
Both Blinder and Feldstein concluded that the fiscal path on which Congress has placed the U.S. is a road to economic ruin. Because of past decisions -- or lack thereof -- the Bush tax rates are set to expire, the payroll tax cuts will end and unemployment benefits will be curbed on Jan. 1, Blinder points out. And last summer's debt ceiling fiasco ordained $1.2 trillion in spending cuts because the less-than-Super Committee failed to trim $1.5 trillion in deficits over 10 years, he adds.
.
Feldstein calculates a tax increase of $512 billion in 2013 is equivalent to 1.9% of gross domestic product and would raise the federal government's take to 18.7% of GDP from 15.8%. Revenue as a percentage of GDP would increase to 19.8% in 2014 and remain over 20% for the rest of the decade.
.
"A sustained tax increase of that magnitude would push the U.S. into a new and deep recession next year," Feldstein concludes.
.
Blinder and Feldstein agree Congress must act to prevent this Road Runner-like hurtle off the fiscal cliff. Nothing is likely to get done during the election campaign. That leaves only the lame-duck session at year-end as the window of opportunity.
.
The political futures markets such as Intrade.com currently suggest President Obama will win a second term while the Republicans will capture the Senate as well as the House of Representatives, making for a completely divided Washington next year. "While neither party would want to see the economic downturn that would result from failure to achieve a compromise, accidents do happen," Feldstein observes.
.
Michael T. Darda, chief economist and market strategist for MKM Partners, is less pessimistic. Some sensible compromise with a "Simpson-Bowles feel to it (base broadening to raise revenue, rate streamlining to limit the economic fallout on incentives and the economy)" could be in prospect.
Fiscal concerns could produce for the stock market "a multi-month consolidation starting in the fall until policy uncertainty begins to lift," he writes, but that history doesn't show equities will suffer if tax rates rise.
.
In the 10 episodes in which income-tax rates increased in the last century, stocks rose in six instances and fell in four, Darda finds. In the year before tax hikes, stocks rose in seven instances and fell in three. The average rise in the Standard & Poor's 500 in the 10 periods income-tax rates rose was 5.5%, while the average rise in the year before was 6.5%.
."This suggests that other forces (monetary policy, the health of the commercial-banking system, credit markets, the business cycle) were likely more important to market performance. Moreover, many of tax hikes in our sample were associated with wars, when the public's tolerance for tax hikes would be higher."
.
To be sure, Darda concludes that "supply-side shifts" cannot be offset with "easier money." That's unlikely, he writes, given the compromises required in a divided government. Indeed, that would be a formula for stagflation. But, as Feldstein reminds, accidents do happen.
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