A New Deal For A New American Dream

Four years ago, when President Obama was first elected, the US economy was experiencing harsh recession. The collapse was initiated by the burst of the housing bubble in a context of excessive households’ indebtedness. The consequences rippled through the entire US economy, leading to a financial crisis and a surge in the number of unemployed people. With declining tax receipts and increasing social benefits payments, State and local governments’ finances suffered, which in turn led to drastic spending cuts and tax increases as their budgets have to be balanced.

The Federal government did not have any choice but to come to the rescue. The emergency support to the financial sector, to other major US firms (such as the car industry) as well as to State and local governments came on top of collapsing tax revenues and surging social benefits payments, resulting in an impressive widening of the Federal budget deficit.

This was made worse by the effort from the government to revive the economy through lower taxes and higher spending. For four years in a row, the Federal budget deficit has been larger than USD 1,000 bn and the US federal debt held by the public doubled between 2007 and 2012, from 36% to 73% of GDP.

The Federal debt is definitely the very first priority of the freshly re-elected President Obama. There is still no incentive from financial markets to put the debt back on a sustainable path. The pressure is unquestionable, though. Over the last two years, the constant bargaining between a Republican House of Representatives and Democrat Senate and President together with the agreement that allowed the federal debt ceiling to be raised in August 2011, created the perfect storm, a.k.a. the “Fiscal Cliff." If unresolved, it would result in tax increases and spending cuts in 2013 (calendar year) amounting to USD 600 bn, i.e. 5% of GDP, an adjustment comparable in size only to what Greece had to implement in 2011, a shock that resulted in a harsh deepening of the recession.

On top of that is the need for once more raising the Federal debt ceiling before next February. Before August 2011, this was a non-event but then, Republican Representatives made it clear that it was now a blackmailing tool: there is no doubt that they will not accept any deal that does not come with some cuts in Federal spending. In short, the only way to avoid the Fiscal Cliff and raise the Federal debt ceiling is through fixing medium-term Federal government finances.

Large because the level of tax remains relatively moderate in the US, while the complexity of Federal taxes (both on individuals and corporations) makes it possible to increase tax revenues without increasing tax rates. Narrow because the latest elections just very marginally changed the balance of power in Washington, D.C.: the President remains the same, Democrats just slightly increased their Senate majority, while the House of Representatives is still held by Republicans, even if their lead inched down.

By Alexandra ESTIOT

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