Political standoff has US on path to 'fiscal cliff'

Obama and Mitt Romney rarely mention cliff on campaign trail

As the US candidates battle it out in the final weeks of the campaign another showdown looms, with the world's largest economy coasting towards a potentially disastrous "fiscal cliff."

If President Barack Obama's Democrats and Republicans in Congress cannot strike a deal by December 31, then the already sluggish economy will be hit hard by sharp cuts in government spending and a surge in taxes.

It's a prospect that has businesses holding back investments and hiring and global bodies like the International Monetary Fund issuing warnings.

And yet Congress is not even discussing a way out, and Obama and his Republican rival Mitt Romney rarely mention the cliff on the campaign trail.

"Going over the fiscal cliff would reduce the deficit quickly, but would damage the economy in the process," said Gary Thayer of Wells Fargo Advisors.

"Neither party is willing to make a deal before the election results are clear."

Without a deal, the government will have to cut some $109 billion in spending next year which, along with the tax increase, will remove some $500 billion from the economy, according to the Congressional Budget Office.

The spending cuts will be split between defense and non-defense parts of the budget. Government contractors will lose business and tens of thousands of civil servants could be furloughed.

The CBO says the austerity could shrink the economy 0.5 percent next year and push unemployment back up to 9.1 percent, from the current 7.8 percent.

The impact would hit the global economy, slowing growth in developed and developing countries alike, according to the IMF.

"The US is in danger over time of losing its status as a reserve currency if we don't start getting our fiscal house in order," said Steve Bell, a former Senate budget committee staffer now with the Bipartisan Policy Center.

"If we don't come to some substantial agreement over the next say 12 months, you're going to see a lot of people start to lose confidence in us both economically and militarily."

No action likely before the elections

The cliff is no accident: it was designed by the very politicians who want to avoid it, part of a deal in August 2011 to persuade Republicans to stop blocking the increase in the country's borrowing ceiling.

The two sides came up with was a poison pill: if they could not agree on a more moderate plan to address the country's gaping deficit and enormous debt, they would have to automatically implement a 10-year plan to radically slash $1.2 trillion in spending beginning in 2013.

Both sides hoped to agree on a more palatable plan, but with the November 6 presidential and congressional elections in sight, Republicans bristled at the idea of tax hikes and Democrats resisted major spending cuts.

Now, unless they can reach a deal, a package of tax cuts renewed and expanded in 2010 to boost the weak economy will expire, adding some $2,000 to the tax bill of the average US family, according to the Tax Policy Center.

Congress can still rewrite the laws before the end of the year, and a group of eight senators from both parties has held quiet discussions to lay the groundwork for a post-election deal.

But the two sides remain deeply divided.

Obama is refusing to accept any compromise that does not increase taxes for the wealthy, and Republicans reject tax hikes.

Analysts say much depends on how November's vote comes out. The winners will not take office until late January.

If the Republicans capture the White House and both houses in Congress, they could be in no mood to negotiate with Democrats in the "lame duck" period.
In that case, the economy could head over the precipice on January 2.

 

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