Peter Jones: Can America hold back the tide?

AS presidential elections loom, the US economy faces rising uncertainty, with huge implications.

Today, the US Democrat party’s national convention kicks off in Charlotte, South Carolina. Officially, it is about nominating President Barack Obama as the party’s candidate in November’s presidential elections. There will surely be lots of attention-grabbing razzamatazz, but behind it lurks the black cloud of the most serious domestic political problem America has perhaps ever faced.

It is variously called “taxmageddon” or, a bit less apocalyptically, the fiscal cliff. And if American politicians make a botch of dealing with it (and recent history says they will), the global, and hence our, economy could take quite a battering. Thanks in part to previous political failures, America faces a conjunction of two big tax and public spending jolts on 1 January, 2013. First, you may recall that in 2011, the US faced a budget crisis in which policy-makers had to either raise the ceiling on the amount of US federal debt, or cut spending drastically, putting millions out of work.

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A last minute compromise saw the debt ceiling raised, but at a price of installing spending caps that will become law in January 2013. It means that the US government will have to cut spending by $109 billion, or about 4.4 per cent of the federal government’s budget, every year for the next nine years.

Secondly, tax cuts made by President George W. Bush totalling between $440-500bn are due to expire. According to the Tax Policy Centre, this will impose average tax increases of $3,700 (£2,330) on about 83 per cent of US households.

The tax cuts were introduced, well before the financial crisis, as an economic stimulus. They should have expired in 2010, but were extended for a further two years by President Obama. By now, it was assumed, economic recovery would be well under way.

But it isn’t. And if these spending cuts and tax rises come to pass, the non-partisan Congressional Budget Office has calculated, they will push America back into recession and add about 2 million to the 8 million unemployed Americans.

And of course, this is election time, which means that no serious decisions will be taken about dealing with these problems until after election day on 6 November. Even then, action is uncertain, especially if there is a change in party control of the presidency and Congress.

Under such circumstances, Congress and the president become lame ducks, unable to take much action unless there is cross-party agreement because of the new administration mandated by the voters and which does not take office until 20 January.

This is causing huge uncertainty. Nearly half of the spending cuts will hit defence, and big defence companies are already warning they will have to lay off hundreds of thousands of workers. Business investment is being put on hold until the political way ahead looks clearer, and consumers, worried they may either face losing benefits or having to pay more taxes, are keeping their money in their wallets.

All this is coming at a time when the US economy is unprecedentedly weak and Americans are facing, perhaps for the first time ever, the prospect of permanent declines in their living standards.

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The median wealth of the American family has fallen by about 30 per cent in the last five years, mainly driven by a big fall in house prices. That in turn means that about a third of households have outstanding mortgage debt which is more than their home is worth.

The official unemployment rate is at about 8 per cent, the longest it has been that high since the Great Depression of the 1930s. Some reckon that the actual unemployment rate, once you add in those who are in stop-gap part-time work and those who have just given up trying to find a job, is above 20 per cent.

Government welfare payments are now making up nearly a fifth of US household income. In March this year, 46.4 million Americans, one in seven, were receiving food stamps. And this in a country which prides itself on its stand-on-your-own-two-feet culture.

In an economy which is teetering on the brink of recession, raising taxes and cutting spending are precisely the opposite of what is needed to generate recovery. Of course, both the presidential camps agree. And, just as naturally, they disagree vehemently on how that should be done.

President Obama wants to continue the tax cuts, but only for individuals earning less than $200,000 a year, or for married couples earning less than $250,000 a year. The Republicans’ Mitt Romney says he would continue all the tax cuts for everyone and then add some more.

Mr Romney also says he will make big spending cuts, including abolition of President Obama’s extension of Medicare, the US public health service. Defence spending will be increased, but lots of other federal budgets will be slashed to reduce spending as a percentage of GDP from about 24 per cent to 20 per cent over four years.

President Obama says he will make some cuts to welfare spending, but is vague on the details, while he proposes to increase spending on infrastructure and contribute more to state and local governments.

Both sides say their plans will progressively reduce the federal spending deficit. But how much the gap between what the government spends and raises in tax revenues will be cut depends on their forecasts for economic growth – which look wildly optimistic.

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There ought, you might think, to be enough overlap between the plans for a compromise to be thrashed out if the current political gridlock between a Democrat presidency and a Republican Congress is maintained. But both sides have red line issues – the Democrats won’t countenance any dismantling of Medicare, and Republicans are pledged to resist any tax increases, including reversals of previous time-limited tax cuts.

You may recall that the last time US politicians faced such a crunch decision – over raising the debt ceiling – they argued, delayed and squabbled so much that Standard & Poors cut the federal government’s triple-A credit rating.

The chances of another stand-off are high. And with all the uncertainty the British economy faces from the ongoing eurozone crisis, a bout of US uncertainty is the last thing we need. Lay in stores and guard your money carefully, this could be an extremely chilly winter.