US dangling on the fiscal cliff

ONCE again US Congress has reached last minute deal to avoid "the fiscal cliff" but the deal provides only a short-term breathing space.

The bill which permanently extends the 'Bush tax cuts' for most taxpayers, except for the wealthiest. The bipartisan deal averts most of the almost USD 600billion in tax increases and spending cuts implying that significant fiscal tightening will not occur in 2013.

That said, the US will go over some of the cliff:

• Both the Republicans and Democrats did not seek an extension of the temporary two percentage point payroll tax cut that was agreed in late 2010. This rate will revert to its previous level effective from 1 January 2013.

• The sequestered spending cuts, amounting to around USD110billion in across the board spending cuts, have been deferred by just two months. All up, the full 'fiscal cliff' has been avoided, ie up to a four percentage point contraction from GDP growth in 2013. However, fiscal policy will still be contradictory in 2013. The impact of this is likely to be felt largely in Q1 2013. Of the changes to revenue, a little more than half has been avoided. Of the changes to expenditure, these have predominantly been deferred for two months until the end of February.

US politicians must now work toward increasing the debt ceiling, which is currently USD16.4 trillion. An increase in this limit needs to occur before the end of February. Negotiations to lift this ceiling may be protracted and messy.

An increase in the debt ceiling of about USD1.5trillion is probably needed. Under the so called Boehner rule, Republicans will want savings of a comparable size to match any increase in the debt limit, meaning that if the debt ceiling is raised by USD1trillion then savings of USD1trillion need to be found - likely over a 10 year period.

Republicans favour cutting spending, particularly entitlement spending. On the other hand, President Obama and the Democrats want any future deficit reduction deal to be balanced - that is, any spending cuts will be paired with additional revenues.

The next immediate concern for US politicians is lifting the debt ceiling. Associated with this problem is the need for a comprehensive long-term fiscal consolidation plan.

These negotiations are likely to prove challenging and a source of volatility for markets in the next couple of months.

Rick Rutten is an Authorised Representative of RI Advice Group P/L. This information is general advice only.

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