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Despite market woes, Washington optimistic for fiscal cliff deal

The fiscal cliff saga moves from Prologue to Chapter One this week, as Congress resumes after its election hiatus, and President Barack Obama meets House and Senate leaders to begin negotiations on how to avoid a year-end budget crisis.

By now, the stakes are well known. Tax increases and spending cuts worth a combined $607-billion (U.S.) are scheduled for Jan. 1. The Congressional Budget Office, the Federal Reserve, the International Monetary Fund and others say the fragile U.S. recovery is too weak to absorb such a blow. Going over the cliff would cause a recession.

The Standard & Poor's 500 Index fell more than two per cent last week after the Nov. 6 election reproduced the political alignment that has achieved little of substance for two years.

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But the dark mood on Wall Street contrasts with the sentiment in Washington, where the post-election rhetoric is optimistic. "There is a basis for a deal" on the fiscal cliff, Bob Corker, a Republican senator from Tennessee, said Sunday on Fox News Sunday. Kent Conrad, a Democratic senator from North Dakota, said on the same program that he "absolutely" believed an agreement was within reach.

Market sentiment is a wild card in negotiations that most expect will drag well into December, if not to the year's final hours, as politicians seek maximum leverage.

The White House on Friday characterized the fiscal-cliff negotiation as one that will take place in a window of 53 days. That's how long is left before tax rates that were temporarily lowered by the Bush administration – and extended by President Barack Obama – revert to Clinton-era levels.

The window, however, could be narrower.

Investors will surely lose patience with Washington before the clock runs out on the year 2012. Having watched last year's brinksmanship over raising the debt ceiling, traders and executives quite likely have their own deadlines for taking defensive strategies that would roil financial markets.

"What may happen is that before Dec. 31, you could see the effects," Jamie Dimon, chief executive of JPMorgan Chase, the U.S.'s largest bank, said in an interview with CNBC on Friday. People will "react and try to protect themselves from a possible and pending recession," he said.

It's early, to be sure, but the contours of an agreement on the fiscal cliff already are taking shape.

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On Wednesday, Republican House Speaker John Boehner said he was open to increasing "revenue" by closing loopholes and simplifying the tax code, while stating clearly that Republicans opposed raising individual tax rates. On Friday, Mr. Obama said individuals who earn more than $250,000 a year must pay more taxes, although he notably avoided equating that condition to higher individual rates.

Both comments were nuanced, but they suggest a path to an agreement could lie in curbing or eliminating hundreds of billions of dollars in tax breaks, many of which favour the wealthy.

For example, Mr. Conrad noted Sunday that there is close to a 20-percentage-point gap between the income-tax rate paid by most Americans and the lower levy on capital gains that mostly benefits the rich. "If Republicans step forward with that revenue piece, we will be able to find a solution," Patty Murray, a Democratic senator from Washington, said Sunday on ABC's This Week.

Most of the attention last week was focused on Mr. Boehner's softening stance on taxes. In return, Republicans will expect Democrats to give ground on major social programs such as Medicare and Medicaid. "Entitlements are choking us," Saxby Chambliss, a Republican senator from Georgia, said on This Week.

Mr. Obama has indicated that entitlement programs are on the table. But as Mr. Chambliss said Sunday, there isn't enough time to overhaul Medicare, Medicaid, Social Security and the tax code before the end of the year. Instead, leaders in both parties appear to favour what Mr. Corker called a "down payment" to show investors that the U.S. is serious about its budget issues and a roadmap to guide negotiations in 2013.

This could work, provided the good-faith gestures on display in Washington are genuine. Not everyone is convinced that they are. "The jury is still out on the substance," of Mr. Boehner's remarks on revenue, Chris Van Hollen, a Democratic congressman from Maryland, said on Fox News Sunday.

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Comments like that will keep Wall Street from sharing Washington's newfound optimism. A resolution to the fiscal cliff before the end of the year is the most likely outcome, but the path will be a bumpy one.

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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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