Can America escape its $1.3 trillion black hole?

An impasse in Congress over spending cuts could send the US spinning into recession
  • @dusborne

The United States found itself last night on an express train to historic cuts in domestic and military spending that could quickly shrink its global standing and threaten a fresh recession in the wake of the unceremonious collapse late on Monday of bipartisan deficit-cutting talks.

Click here to view the graphic 'In the red: How the deficit crisis could unfold'

Numbness mixed with panic settled over Washington following the admission of defeat by the bipartisan super-committee formed in August to find ways to cut federal spending by $1.3 trillion over 10 years. The legacy of its failure promises to be complicated. All sides darted in different directions to start the blame game. In New Hampshire, President Barack Obama appealed to Congress at least to extend middle-class tax breaks that are set to expire, while runners for the Republican presidential nomination excoriated him for a failure of leadership in another debate.

If there is panic it is partly because the terms under which the committee was created stipulated that, in the event of its failure, a swathe of cuts would automatically come in to effect to achieve the same reduction in spending. They are due to begin biting in January 2013 and hold terror mostly for Republicans because they would include a $500bn dive in funding for the Pentagon.

Mr Obama is already warning Congress against making any attempt to challenge the automatic nature of those cuts even if his own Defence Secretary, Leon Panetta, is on the record warning that they would spell catastrophe for the US military. If carried out, he says, the US would have "the smallest ground force since 1940, the smallest number of ships since 1915 and the smallest Air Force in its history".

Democrats have reason to quake also, however, because half of the automatic cuts will affect programmes close to their hearts like education and healthcare. Common sense would suggest that the prospect of these cuts will drive Congress to try again to negotiate a package of spending reductions before they come into effect. But that may be pie-in-the-sky as the US enters an election year.

The super-committee's failure will now compound the sense across the country that Congress is incapable of accomplishing anything, a perception that is bad for everyone on Capitol Hill but probably also for Mr Obama as well. The mood has been further darkened by a downwards revision of US economic growth in the last quarter from 2.5 per cent to 2 per cent.

"It's the chief executive's job to bring people together and to provide leadership. I don't see that happening," Michael Bloomberg, the Mayor of New York, told reporters, adding that the failed talks were another "damning indictment of Washington's ability to govern this country".

If Mr Obama indeed seemed to be absent as the super-committee writhed in recent weeks it was by design. His aides did not want him to be associated with a venture that looked set to fail. Yet it was a strategy that risked making him look gutless.

"Americans expect their President to be a leader, not a calculating politician taking a back seat so he can get re-elected," said Kirsten Kukowski of the Republican National Committee. "The longer Obama punts on important issues, the more Americans will start questioning whether he's the same President they were sold in 2008."

The sharp fall in stock prices on Monday and further losses yesterday were seen by many as a sign that investors were again also losing faith in the ability of the US to control its own fate. So far at least the main rating agencies seem disinclined to downgrade America's debt status. That would surely change, however, if Congress found a way to undo the automatic cuts and replace them with nothing much.

While the automatic cuts indeed promise to do what the super-committee could not do in terms of slaying the budget deficit – the gap between spending and revenue might be cut by half especially if tax cuts for the rich are allowed to expire at the end of 2012 – there are fears that the drop-off in federal spending would be too sudden and would tip the country back into recession.

The battle next year over the tax cuts for the rich alone is likely to be seismic. At the core of the current dysfunction in Washington is the unwillingness of Republicans to contemplate anything but the tiniest increases in taxation. Democrats who are committed to protecting social-protection programmes say some revenue-raising measures are vital.

"We start [from] fundamentally different premises," Senator Pat Toomey, a Republican and former member of the defunct committee, said of the other party yesterday. "They are advocates for big government. If we are gong to have a European-style large government then you need bigger taxes to fund that."

The more immediate problem for Mr Obama however is the scheduled expiry at the end of next month of breaks in what middle-income earners pay in Social Security tax.

A failure to renew them could cost the average American family $1,000 next year, he said in New Hampshire.