Satyajit Das: Fiscal cliff not big enough to solve US debt problem

Stateside View: What is needed is a review of all spending to better target it and align it with tax revenues

Ironically, the approaching fiscal cliff (scheduled reductions in the US budget deficit) may, at least on the face of it, "improve" public finances, reducing the deficit and slowing the increase in debt levels. But the fiscal cliff will not of itself solve America's financial problems. It is simply not high enough.

In January, in the absence of political agreement, a series of automatic tax increases and spending cuts will be triggered. These were part of the 2011 legislative package which increased the debt ceiling, allowing the government to continue to borrow. Several temporary tax cuts will expire. The total amount involved is around $500bn (£300bn) through to September next year. Automatic spending cuts will also commence, totalling $600bn per year and $6.1 trillion over 10 years.

The automatic tax increases, non-renewal of tax cuts and spending cuts are equivalent to 5 per cent of GDP. The non-partisan Congressional Budget Office (CBO) has estimated that the tax increases and spending cuts would reduce output by 3 per cent and increase unemployment to 9.1 per cent by the end of 2012.

President Barack Obama's ability to implement policy is constrained by continued Republican control of the House of Representatives. The Republicans remain reluctant to entertain tax increases or reductions in exemptions. The Democrats remain reluctant to consider reductions in entitlements and spending.

Mr Obama asserts that he has a mandate to reform the budget, especially increase taxes on wealthier Americans. John Boehner, Republican House Speaker, has been conciliatory, signalling a willingness to consider some higher taxes. A short-term compromise will be needed, entailing extension in some tax cuts and delaying some spending cuts. Negotiations on deeper structural tax and spending reforms may take longer. The latter would focus on some tax increases and some adjustment to spending.

Mr Obama may get some higher taxes. Republicans might accept higher income taxes, particularly for those earning more than $1m a year (rather than the $250,000 currently proposed). Some tax deductions and reporting loopholes may also be eliminated. In return, the administration may agree to changes in entitlement, such as higher Medicare retirement age and changes to indexation of social security benefits for inflation. There would probably also be cuts in spending on defence and other social welfare programmes.

The fiscal cliff if it is avoided, or the measures likely to be adopted, may not to be enough to address the deep-seated problems. What is needed is a radical overhaul of the tax system, including probably a value-added tax and wind-back of complex deductions and subsidies. What is also needed is a review of all spending, including defence and social welfare, to better target expenditure and align it with tax revenues.

But even with this action, without strong economic growth and falling unemployment, it is hard to see a significant improvement in American public finances. A recent CBO report concluded that "[very few policies] are large enough, by themselves, to accomplish a sizeable portion of the deficit reduction necessary". This means the US will probably still spend more than it gets in taxes, so US government debt will rise. This will force the Federal Reserve to continue existing policies, especially debt monetisation by purchasing government bonds and devaluation of the currency.

Given that the US constitutes around 25 per cent of the global economy, it is unlikely America's problems will stay in America. US dollar devaluation will create pressure for appreciation of other currencies, forcing other nations to implement measures, such as zero interest rate policies, QE programmes or capital controls. Foreign investors in US dollars and government bonds are likely to suffer losses.

How long the US can continue its profligate ways is unknown. But as the economist Herbert Stein observed: "If something cannot go on forever, it will stop."

Satyajit Das is a former banker and author of 'Extreme Money' and 'Traders Guns & Money'

Start your day with The Independent, sign up for daily news emails
Sport
England's women celebrate after their 3rd place play-off win against Germany
Women's World CupFara Williams converts penalty to secure victory and bronze medals
Arts and Entertainment
Ricardo by Edward Sutcliffe, 2014
artPortraits of LA cricketers from notorious suburb go on display
News
newsHillary Clinton comments on viral Humans of New York photo of gay teenager
Arts and Entertainment
The gang rape scene in the Royal Opera’s production of Gioachino Rossini’s Guillaume Tell has caused huge controversy
music
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Assistant / Buyer

£15000 - £17000 per annum: Recruitment Genius: This company offers a range of ...

Recruitment Genius: Customer Service Advisor

£15000 - £16000 per annum: Recruitment Genius: Customer Service Advisors are r...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45K: SThree: SThree were established in 1986....

Recruitment Genius: Compliance Manager

£40000 - £60000 per annum: Recruitment Genius: A Compliance Manager is require...

Day In a Page

Is this the future of flying: battery-powered planes made of plastic, and without flight decks?

Is this the future of flying?

Battery-powered planes made of plastic, and without flight decks
Isis are barbarians – but the Caliphate is a dream at the heart of all Muslim traditions

Isis are barbarians

but the Caliphate is an ancient Muslim ideal
The Brink's-Mat curse strikes again: three tons of stolen gold that brought only grief

Curse of Brink's Mat strikes again

Death of John 'Goldfinger' Palmer the latest killing related to 1983 heist
Greece debt crisis: 'The ministers talk to us about miracles' – why Greeks are cynical ahead of the bailout referendum

'The ministers talk to us about miracles'

Why Greeks are cynical ahead of the bailout referendum
Call of the wild: How science is learning to decode the way animals communicate

Call of the wild

How science is learning to decode the way animals communicate
Greece debt crisis: What happened to democracy when it’s a case of 'Vote Yes or else'?

'The economic collapse has happened. What is at risk now is democracy...'

If it doesn’t work in Europe, how is it supposed to work in India or the Middle East, asks Robert Fisk
The science of swearing: What lies behind the use of four-letter words?

The science of swearing

What lies behind the use of four-letter words?
The Real Stories of Migrant Britain: Clive fled from Zimbabwe - now it won't have him back

The Real Stories of Migrant Britain

Clive fled from Zimbabwe - now it won’t have him back
Africa on the menu: Three foodie friends want to popularise dishes from the continent

Africa on the menu

Three foodie friends want to popularise dishes from the hot new continent
Donna Karan is stepping down after 30 years - so who will fill the DKNY creator's boots?

Who will fill Donna Karan's boots?

The designer is stepping down as Chief Designer of DKNY after 30 years. Alexander Fury looks back at the career of 'America's Chanel'
10 best statement lightbulbs

10 best statement lightbulbs

Dare to bare with some out-of-the-ordinary illumination
Wimbledon 2015: Heather Watson - 'I had Serena's poster on my wall – now I'm playing her'

Heather Watson: 'I had Serena's poster on my wall – now I'm playing her'

Briton pumped up for dream meeting with world No 1
Wimbledon 2015: Nick Bollettieri - It's time for big John Isner to produce the goods to go with his thumping serve

Nick Bollettieri's Wimbledon Files

It's time for big John Isner to produce the goods to go with his thumping serve
Dustin Brown: Who is the tennis player who knocked Rafael Nadal out of Wimbeldon 2015?

Dustin Brown

Who is the German player that knocked Nadal out of Wimbeldon 2015?
Ashes 2015: Damien Martyn - 'England are fired up again, just like in 2005...'

Damien Martyn: 'England are fired up again, just like in 2005...'

Australian veteran of that Ashes series, believes the hosts' may become unstoppable if they win the first Test