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US elections: The winner is … gridlock
07 Nov 2012
Kevin Logan, Chief US Economist
Barack Obama was re-elected as president but the 2012 elections returned a divided government to Washington. No one party has gained control, so the legislative progress will depend on compromise. And with few strong incentives for different factions to give in on the issues that matter most to them, we face long, drawn-out negotiations with only piecemeal progress on pressing fiscal issues such as the looming ‘fiscal cliff’.
A grand bargain on tax hikes and spending cuts is unlikely in the short-term. We expect uncertainty and delay, with decisions on longer-term solutions for the federal budget deficit taking place only later
With a larger majority in the Senate, the Democrats are likely to take a harder line with Republicans in the House of Representatives on upcoming budget negotiations. All tax and spending legislation begins in the House, and the Republican majority has been insisting that only spending cuts – not increases in tax revenues – be used to lower the federal budget deficit. This is contrary to the approach favoured by the Democrats, who have insisted on a mix of tax increases and spending cuts to rein in the deficits.
Progress on deficit reduction will likely require compromises with each side giving ground on some issues in exchange for concessions from the other. President Obama featured tax increases on higher earners in his campaign and is likely to assert that his election victory gives him a mandate to ask the Congress to increase their taxes. Since the Republican leaders in the House disagree, stalemate over budget negotiations may ensue.
The Congress has only a few weeks after the election to pass legislation affecting the tax hikes and spending cuts that comprise the fiscal cliff. They may not make much progress, partly because most politicians in Washington do not view the tax increase and spending cuts scheduled for January 2013 as a ‘cliff’. They see it more as a ‘slope’ that they can begin to walk down, then turn round without too much difficulty by reversing tax hikes and rescinding spending cuts retroactively.
The lame-duck Congress could adopt an agreement in principle to replace most aspects of the fiscal cliff with tax and spending changes to be decided later in 2013. However, substantive negotiations may simply be postponed until the new Congress takes office in January, leaving a fog of uncertainty over the outlook for fiscal policy and leading to increases in financial market volatility.
The Republicans are very unlikely to vote for any legislation that includes increasing the top tax brackets or raising taxes on capital gains or dividends, even if the legislation prevents all the other tax increases that are scheduled to take place in January. If they are unwilling to compromise, we will go into January with all the tax increases coming into effect. At that point, the Republicans might vote for legislation that lowers tax rates, even if the legislation does not involve cutting the rates for all taxpayers. This way, the Republicans can stick to their pledge of not voting for a tax increase.
Compromise may not come easily, however. The Republican Party has forged an identity for itself as an anti-tax party and it may be very difficult for its leaders to compromise on that position unless they can show that they have wrung some concessions out of the Democrats. Those concessions will have to come, in our view, on the spending side of the federal ledger.
However, it is not clear that Democrats will be willing to concede much, especially after coming off a hard-fought electoral victory in which they held on to the White House and increased their majority in the Senate. If the Democratic leaders insist on protecting the federal programs favoured by their constituents, then they may not be able to make much headway with their Republican counterparts on an overall agreement that balances revenue increases and spending cuts.
We are not especially hopeful that much progress will be made on reaching an agreement on how to go about reining in the long-term federal budget deficit. The two parties still remain too far apart in terms of their approaches to the problem with one side emphasizing spending cuts and the other side demanding a more balanced approach that includes sizable revenue increases. Given these differences, we do not expect the main aspects of the fiscal cliff will be resolved easily in the near term either.