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
News
peoplePair enliven the Emirates bore-draw
Arts and Entertainment
tvPoldark episode 8, review
News
Britain's opposition Labour Party leader Ed Miliband (R) and Boris Johnson, mayor of London, talk on the Andrew Marr show in London April 26
General electionAndrew Marr forced to intervene as Boris and Miliband clash on TV
News
United States President Barack Obama, right, uses actor Keegan-Michael Key from Key & Peele to play the part of 'Luther, President Obama's anger translator'
video
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
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

Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

Ashdown Group: Business Analyst - Financial Services - City, London

£50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...

SThree: Trainee Recruitment Consultant

£18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: Did you know? SThree is the o...

Day In a Page

General Election 2015: Chuka Umunna on the benefits of immigration, humility – and his leader Ed Miliband

Chuka Umunna: A virus of racism runs through Ukip

The shadow business secretary on the benefits of immigration, humility – and his leader Ed Miliband
Yemen crisis: This exotic war will soon become Europe's problem

Yemen's exotic war will soon affect Europe

Terrorism and boatloads of desperate migrants will be the outcome of the Saudi air campaign, says Patrick Cockburn
Marginal Streets project aims to document voters in the run-up to the General Election

Marginal Streets project documents voters

Independent photographers Joseph Fox and Orlando Gili are uploading two portraits of constituents to their website for each day of the campaign
Game of Thrones: Visit the real-life kingdom of Westeros to see where violent history ends and telly tourism begins

The real-life kingdom of Westeros

Is there something a little uncomfortable about Game of Thrones shooting in Northern Ireland?
How to survive a social-media mauling, by the tough women of Twitter

How to survive a Twitter mauling

Mary Beard, Caroline Criado-Perez, Louise Mensch, Bunny La Roche and Courtney Barrasford reveal how to trounce the trolls
Gallipoli centenary: At dawn, the young remember the young who perished in one of the First World War's bloodiest battles

At dawn, the young remember the young

A century ago, soldiers of the Empire – many no more than boys – spilt on to Gallipoli’s beaches. On this 100th Anzac Day, there are personal, poetic tributes to their sacrifice
Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves

Follow the money as never before

Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves, reports Rupert Cornwell
Samuel West interview: The actor and director on austerity, unionisation, and not mentioning his famous parents

Samuel West interview

The actor and director on austerity, unionisation, and not mentioning his famous parents
General Election 2015: Imagine if the leading political parties were fashion labels

Imagine if the leading political parties were fashion labels

Fashion editor, Alexander Fury, on what the leaders' appearances tell us about them
Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

The architect of the HeForShe movement and head of UN Women on the world's failure to combat domestic violence
Public relations as 'art'? Surely not

Confessions of a former PR man

The 'art' of public relations is being celebrated by the V&A museum, triggering some happy memories for DJ Taylor
Bill Granger recipes: Our chef succumbs to his sugar cravings with super-luxurious sweet treats

Bill Granger's luxurious sweet treats

Our chef loves to stop for 30 minutes to catch up on the day's gossip, while nibbling on something sweet
London Marathon 2015: Paula Radcliffe and the mother of all goodbyes

The mother of all goodbyes

Paula Radcliffe's farewell to the London Marathon will be a family affair
Everton vs Manchester United: Steven Naismith demands 'better' if Toffees are to upset the odds against United

Steven Naismith: 'We know we must do better'

The Everton forward explains the reasons behind club's decline this season
Arsenal vs Chelsea: Praise to Arsene Wenger for having the courage of his convictions

Michael Calvin's Last Word

Praise to Wenger for having the courage of his convictions