Quick action by President Obama and Congress could still help the economy escape the full impact of hundreds of billions in tax increases and automatic spending cuts set to take effect shortly after the last minutes of 2012 tick away next week. But if the deadlock in Washington persists much longer than a few weeks, the consequences will quickly mount, economists warn.
Until late last week, most observers had expected the president and Congressional Republicans to come up with at least a short-term compromise before the year-end deadline. But the failure of Speaker John A. Boehner to win support for tax increases on the wealthiest Americans from fellow House Republicans has forced many economic observers to reconsider what might happen if political leaders remain deadlocked into 2013.
Wall Street is still betting on a quick deal, but that confidence is misplaced, said Julia Coronado, chief North American economist at BNP Paribas. “Markets have been incredibly complacent about this,” she said. If a compromise cannot be found by Jan. 1, she said, “the markets will take that hard.”
Some hits — like a two percentage point increase in payroll taxes and the end of unemployment benefits for more than two million jobless Americans — would be felt right away. But other effects, like tens of billions in automatic spending cuts, to include both military and other programs, would be spread out between now and the end of the 2013 fiscal year in September. These could quickly be reversed if a compromise is found.
Similarly, the expiration of Bush-era tax cuts on Jan. 1 would not have a major impact on consumers if Congress quickly agreed to extend them for all but the wealthiest Americans in early 2013, as is widely expected.
Other probable changes, like a jump in taxes on capital gains and dividends, would most likely be felt over a broader period rather than as an immediate blow to the economy.
In the meantime, more observers are contemplating what the impact will be if Washington ignores the year-end deadline and waits until January or February to act.
“It’s still possible they will work something out by the end of the year, but the probability seems reasonably high that we may go into January with no agreement,” said Dean Maki, chief United States economist at Barclays Capital. “But the longer this goes on, the more nervous I get about first-quarter growth. If negotiations were to linger into March, then the first quarter could be much weaker.”
If the impasse lasted even longer and the full force of more than $500 billion in tax increases and spending cuts hit the economy, the Congressional Budget Office predicts the country would slip into recession in the first half of 2013, with unemployment rising to 9.1 percent by the fourth quarter of 2013. But for all the pessimism recently, most observers still think a compromise will be reached, even if it takes a few more weeks.
Negotiations are set to resume in the coming days, following a break for Christmas, although hopes for a so-called grand bargain have faded. Instead, President Obama is pushing for a scaled-back plan that would extend the Bush-era tax cuts on incomes below $250,000, while suspending the automatic spending cuts and extending unemployment benefits.
Michelle Meyer, senior United States economist at Bank of America Merrill Lynch, said there is a 40 percent chance of what she calls a “bungee-jump over the fiscal cliff,” with Congress failing to act until after Jan. 1 but eventually averting the full package of tax increases and spending cuts by mid-January. If that were to happen, she predicts a steep sell-off on Wall Street, which would quickly force political leaders to compromise.
Over all, Ms. Meyer estimates that the economy will grow by just 1 percent in the first quarter of 2013, well below the 3.1 percent pace recorded in the third quarter of 2012.
What’s worrisome, she added, is that consumer anxiety about the fiscal impasse has begun to mount, catching up with business leaders who have been warning of economic danger since summer. “What’s been missing in this recovery has been confidence,” she said. “We’d see a healthy recovery if it weren’t for this uncertainty and the potential shock from Washington.”
Indeed, the economy has been showing signs of life recently. Unemployment in November sank to 7.7 percent, a four-year low. Consumer spending has been picking up, and the housing market has continued to recover in many parts of the country. Overseas worries like slowing growth in China and recession in Europe have also faded.
Those trends have encouraged some observers, like Steve Blitz, chief economist at ITG Investment Research. He estimates that the economy will grow by nearly 2.5 percent in the first quarter if Washington comes up with even a modest compromise. In the absence of a deal, the pace of growth would be more like 1 percent, he said.
“I don’t think that not having a deal going into the new year is all that critical,” Mr. Blitz said. “It doesn’t mean you will immediately go into a recession.”
