Debt Ceiling will force Congress to Act on the Fiscal Cliff

Congressional Republicans and Democrats have not yet resolved their differences over the fiscal cliff. Today, the Treasury Department estimated that the country will hit the $16.4 trillion debt ceiling by the end of the year.

If the country is to stay solvent and not let its credit rating sink further; Congress must take steps to raise the debt ceiling. Now, recall the impasse over raising the ceiling on the national debt 1 ½ years ago? Well get ready for “Déjà vu all over again”.

The congressional stalemate over the debt ceiling debate is responsible for our current gridlock on the fiscal cliff. Congress could not reach a compromise so it put in place draconian spending cuts and huge tax increases that would kick in automatically. The mistaken assumption was that the drastic measures would force Congress to act. It is not done so yet!

While Congress can kick the can down the road on the fiscal cliff, it must act on the debt ceiling. To do so means it must find a solution to the budget deficit. The President is seeking independent power to raise the ceiling, but Republicans are not about to allow that to happen. If you have been sickened by the inability of Congress to address the fiscal cliff, just wait until the debt ceiling debate is reignited.

A small number of Republicans have accepted the fact that taxes on the wealthiest Americans must be increased in order for the negotiations to move forward. At the same time, the Obama administration is indicating a willingness to accept a smaller tax increase on the wealthy than the 39.6% which prevailed before George Bush tax cuts went into effect.

The Obama administration is seeking an agreement that will increase taxes by $1.6 trillion. The GOP plan is offering one half that amount; about $800 billion in revenue. Instead they are proposing to make spending cuts to Medicare and Social Security. The GOP argues that it is package will ultimately reduce the deficit by $2.2 trillion, without raising taxes on the wealthy. The Obama Administration maintains this is impossible.

So, the President appears to be willing to allow the economy to hit the fiscal cliff if the GOP is unwilling to accept tax increases on the wealthy.

Ironically, the uncertainty regarding the fiscal cliff is already influencing individuals to act now, as if we have already hit the cliff.

  • For example, donations to charitable funds run by investment houses such as Fidelity, Charles Schwab and Vanguard have increased by two thirds over last year, the same time. Donations increased in anticipation of lower tax deductions for charitable donations in 2013. However, this means that spending in 2012 is lower than it ordinarily would be.
  • Corporations are accelerating dividend payouts in 2012, rather than waiting until 2013. This means investment decisions are being postponed.
  • Corporations have cut back significantly on investment spending and increased their precautionary borrowing. This means money is being held idle in the coffers of corporations.

The irony is that if a negotiated settlement is not reached, the ultimate negative effects will be mitigated by the precautionary behavior businesses and individuals are taking now.

All of this is happening while we still have not yet fully digested the impact of Hurricane Sandy.  It will take another month or so. In the meantime, if Friday’s jobs report shows 125,000 or more jobs created in November, count that as a major victory.

The other picture that Friday’s job report will clear up is just how devastating the impasse over the fiscal cliff will be on the economy.