The USA is currently the envy of Europe. Its economy is expected to grow by around 2% this year according to the IMF, favourably comparing to the Euro area, where it is predicted there will be a small recession. Even a country like Germany, known for their good finances, is only expected to grow by around 1%. But the difference is that while the eurozone has come to grips with its debt and has been applying austerity measures in most of its countries, the USA has successfully put off any such talk. Whether this is a successful strategy for the EU is up for grabs, as debt reduction has seemingly overtaken growth as the number one target, a policy that has seen the UK and Spain both drop back into recession when a strong recovery should have been taking place. Nevertheless, the USA has an bump in the road coming up that could topple its recovery.
An Uncertain road ahead
Last year, after the USA hit their debt ceiling (a cap on the amount the government can borrow), a debate over increasing the barrier enveloped America. A complex deal was reached where tax increases and spending cuts were postponed till the end of this year, costing the USA their AAA credit status with Standard and Poor. This “Taxmageddon” date will prove costly unless Congress can come up with a deal beforehand, unlikely with a Republican dominated Congress up against a Democratic President – as Barack Obama will have to sign off on any new deal.
The biggest tax increase since 1968.
A range of problems await the USA at the end of the year; an expire of Bush’s tax cuts, a range of spending cuts from last year’s deal, the end of short-term boosts to the economy (e.g. the payroll-tax holiday worth $100 billion a year) and a new debate over another increase of the debt ceiling (already at $16.4 trillion). All this adds up to a $500 billion cut to America’s economy, roughly around 3-5% of GDP, more than enough to tip America back into recession. It doesn’t help that this is an election year, meaning the limelight will be placed on Barack Obama and Mitt Romney’s presidential campaigns rather than this impending crisis. More still, the Republican dominated Congress may wait to see if Mitt Romney can win the election rather than to try and negotiate with Obama once again, resulting in even less time to untangle this web of debt.
Shows the cost of the new tax increases on America’s economy
America will have to deal with this “Fiscal Cliff”, any sidestepping of the issue will lead to even more debt and the possibility of a further downgrading in credit status, as their inability to deal with their debt is confirmed. But maybe allowing the spending cuts to take place would be good for America in the long run; they are cuts across the board and would help ensure a reduction in the budget deficit. It would result in a big fiscal contraction at the start of next year, but would sort out all the mess that the dysfunctional structure of Washington enables.
The USA is heading for a cliff, how big the drop ends up being is down to Congress.