Posted on Thursday, November 11, 2010
WALL STREET wisdom holds that political gridlock is good for the economy. When Democrats and Republicans are busy quarrelling, the theory goes, they have less time to tie up business in red tape or to bust the budget.
That wisdom is about to be tested. On October 29th the government reported that GDP grew no more than 2% at an annual rate in the third quarter, barely enough to keep joblessness from rising, much less to create work for the 8m who lost their jobs during the recession. Growth in the current quarter looks no healthier.
Meanwhile, a series of economic-policy deadlines looms over the next four months (see table). If Barack Obama and Congress cannot meet them, the result could be budgetary disarray and a damaging tightening of fiscal policy.
Mr Obama is proposing several scaled-down stimulus initiatives, such as $50 billion in infrastructure spending and a business-investment tax credit, and will probably press to renew expiring provisions of the old stimulus plan. Extended unemployment-insurance benefits, for instance, expire on November 30th, and Mr Obama’s “making work pay” tax credit on December 31st. But Republicans are unlikely to be receptive, having just won Congress by arguing that stimulus doesn’t work.
Just keeping fiscal policy from tightening unintentionally could prove a challenge. The federal government is now operating without a budget. Congress, unable to pass any of the necessary 12 appropriations bills for the fiscal year that started on October 1st, is relying on a stopgap “continuing resolution” that funds the government at existing levels, but only until December 3rd. Failure to pass a budget, or at least to renew the resolution, would force much of the federal government to shut down, as it did for 21 days in 1995-96 during a standoff between Newt Gingrich’s Republicans and Bill Clinton.
George Bush’s tax cuts all expire on December 31st as well. Mr Obama wants to keep them only for the 98% of households earning less than $250,000 a year. Republicans, and some Democrats, want to extend all of them. Without a deal, says Dave Greenlaw of Morgan Stanley, taxpayers will see the taxes withheld from their pay-cheques jump by an average of 12% in January. Finally, some time between March and April, Congress will have to vote to raise the statutory limit on how much the Treasury can borrow. The “debt ceiling” now stands at $14.3 trillion, about $600 billion above the current level of the debt. Failure to raise it could force huge spending cuts or even raise the spectre of default.
None of those things needs to happen. The bespectacled Eric Cantor, who is likely to take over as majority leader of the House of Representatives, recently told the Wall Street Journal that he did not want the government to shut down.
The elements of a compromise on taxes are already in place: permanent extension of the middle-class tax cuts, plus a temporary extension of the upper-income tax cuts. But there’s many a slip. Republicans have little incentive to co-operate during the post-election session, knowing they will have far more leverage in January, when the newly-elected members take their seats. But the party’s much bigger “tea-party” contingent may make it even harder to strike deals then. Stalemate, even shutdown, could be in store next year.
Despite that, there are potential areas of agreement: Republicans will back Mr Obama’s efforts to complete a free-trade agreement with South Korea. They may also look favourably on any stimulus based on tax cuts not higher spending.
A bipartisan fiscal commission, charged with working out how to balance America’s budget, offers another possible meeting place. Rather than recommending the sweeping changes to taxes and entitlements that America needs, the commission, which is due to report by December 1st, will probably produce modest proposals to trim the deficit in the medium term that can win support from its own members. Even if Congress ignores them, Mr Obama could nevertheless incorporate them into his own budget proposal, which is due by February.
A fight over the debt ceiling could, in fact, force the two sides to negotiate. Or it could do exactly the opposite: prove that, in America, political gridlock makes rational fiscal policy impossible.