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Why the U.S. won’t topple over the fiscal cliff

House Speaker John Boehner has softened his stance on tax cuts in an effort to ease the problems of the deficit.

J. Scott Applewhite/AP

America's fast-approaching fiscal cliff is terrifying, to be sure. But there is something to keep in mind amid all the screaming in the back seat: The legislative process has brakes and its drivers, however reckless, know how to use them.

Under current law, a combination of tax increases and spending cuts worth more than $607-billion (U.S.) will take effect on Jan. 1, 2013, a calendar item that has come to be known as the cliff, a term popularized by Federal Reserve chairman Ben Bernanke.

If the U.S. economy had fully recovered from the financial crisis, this would be considered a good thing. But American companies employ some four million fewer people now than they did in 2007, and GDP only is growing at an annual rate of about 2 per cent, too slow to induce serious hiring. A half-trillion-dollar fiscal contraction now would do wonders for the U.S. balance sheet, but sink the economy into another recession.

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The results of Tuesday's election induced new fear that this might happen. On the surface, it looks like a cementing of the gridlock of the past two years, with Democrats controlling the Senate and White House and the Republicans leading the House of Representatives.

But that same political alignment compromised to raise the legislative debt limit in 2011, an episode that not only confirmed U.S. legislators' penchant for drama, but also their knack for skirting disaster at the 11th hour. This is why most observers in Washington play down the worst-case scenario of the U.S. economy hurtling over the fiscal cliff, in the style of Thelma and Louise.

Even in a divided government, a stop-gap measure always can be found to avoid that fatal plunge.

Short-term budget deals are poor policy, of course. The federal deficit has exceeded $1-trillion (U.S.) for four consecutive years, and the U.S. debt is becoming critically high. At the same time, with growth so weak, any solution to the budget crisis must be applied carefully.

Any expectation that a comprehensive debt solution would be done before Nov. 6, 2012, underestimated the political incentive to do as little as possible – and blaming the other guy for it. As long as the White House and the Capitol were in play, the chance of compromise was close to nil.

But that contest is over; and now a new game begins. The rules and the objectives still are taking shape, but they will be different.

"With the election behind us, one incentive for short-term obstructionism – the hope that the balance of power would soon shift – has disappeared," said Nigel Gault, chief U.S. economist at IHS Global Insight, an advisory firm.

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"The balance of power has not shifted, and important decisions cannot now be postponed until the next elections."

In his recent book The New New Deal, journalist Michael Grunwald documents how Republican leaders in Congress decided within days of President Barack Obama's first win in 2008 that they would do whatever they could to obstruct his progress.

This was a self-preservation strategy against the Democratic wave that swept over Washington four years ago, and it helped the Republicans retake the House in the 2010 mid-term elections. However, Tuesday's election results suggest the strategy has limits. With the unemployment rate near 8 per cent throughout the campaign, and the economy weak, Republicans should have done better. They have every incentive to adopt a new game plan – and they wasted little time doing so.

John Boehner, the House speaker, told reporters in Washington Wednesday that "we're willing to accept new revenue under the right conditions," a softening of the party's stand against the Democratic call for tax increases to narrow the deficit.

Mr. Boehner said new revenue could be found by overhauling the tax code, closing loopholes and thinning out tax breaks. Mr. Obama and Democrats have expressed interest in doing the same. At the same time, Mr. Boehner continued to reject Mr. Obama's desire to raise the taxes on individuals who make more than $200,000 (U.S.) a year.

The President called congressional leaders Wednesday to discuss the fiscal cliff, and Vice-President Joe Biden told reporters that there are "all kinds of potential to be able to reach a rational, principled compromise."

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Comments like these represent a beginning, not an end. Congress resumes for its "lame duck" session next week and is scheduled to adjourn four weeks late. Those days will be dominated by the fiscal cliff.

With a new slate of legislators waiting in the wings, a final budget solution before the end of the year seems unlikely. But even the lamest of ducks can pass legislation averting the short-term fiscal crunch – perhaps leaving tax increases and spending cuts in place as a down payment.

The point would be to create the political space to negotiate a comprehensive, longer-term budget agreement in 2013. A successful end would bring relief, but not an end to the pain. It will take a lot to reverse four years of $1-trillion deficits. The fiscal cliff will become the fiscal hill.

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More

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