Tuesday, January 8, 2013

Having found a Pass around the Fiscal Cliff, What lies Ahead? Or Critiquing the World According to Roubini!

Nouriel Roubini wrote a very elegant piece in the FT onJanuary 4th about the fiscal cliff being averted being a signal that the “US has been let down by it’s leadership”.  Now let me preface this piece by saying that I have the utmost respect for Professor Roubini, not only because he is an excellent economist, but also because he has managed to traverse the void between academia and the perilous world of finance - indeed quite a feat.

His reasoning was that basically the US cannot afford to pay for what it wants if it refuses to raise taxes, so that implies that the leadership didn’t do the right thing in raising taxes on only the very wealthy.  While readers of this blog will know that I favored going over the fiscal cliff because it helps to get the country on the road to fiscal sustainability, I would not go as far as to state that the leadership has let down the country by coming to a deal hours before the effective deadline.  My view was simply that I didn’t see Republicans yielding to demands for higher taxes for anyone, so in those circumstances I thought it better to go over the cliff.  I presupposed that any deal would basically kick the can down the road again.

So in contrast to Professor Roubini, I would assert that the deal demonstrated that the leadership can come together when they really need to, but when they don’t really need to they simply won’t agree.  What he is right about is that voters are going to be hearing a lot more about fiscal issues as they are going to continue to be in the limelight for the next few months at least. 

The raising of the debt ceiling will likely spark more brinkmanship, but how “successful” the sequestrations on the fiscal cliff were, the politicians are likely to opt for a similar strategy again in 2013.  I would suggest that this might be the most successful strategy for the Democrats in terms of forcing the hand of Republicans, in the sense that a further downgrade in the creditworthiness of the US is likely if the country’s politicians don’t compromise again.  This will hang like a Damoclesian sword over the Republicans and will force some modest tax increases maybe in 2014. 

Roubini states that “the US could quite easily come perilously close to stall speed this year – or worse, if the eurozone crisis worsens”. But Roubini ignores several things: i) the US is still on an upswing with the housing and stockmarkets causing wealth effects which will not be hugely impacted by changes in tax rates or cuts in government expenditures; ii) the US dollar is at low levels still which is stimulating the export sector, particularly in relation to EU exports; iii) the best way to generate more tax income is by more economic growth, and iv) why would the eurozone crisis worsen now that Greece appears to have swallowed a growth “poison pill” and the institutional mechanisms are now in place to stem any panic in Spain or Italy? 

In fact, the more I thought about Roubini’s argument, the more I realized that it was contradictory.  How can you claim to be concerned about stalling US growth this year, while at the same time predicting a looming “fiscal nightmare” which implies a preference for going over the fiscal cliff?  The only way I could square Roubini’s circle was to assume that he is concerned about growth in the short term, while being concerned about the US fiscal situation in the long term.  But given the former, why would he want the US to go over the fiscal cliff? 

Let’s pick out a few of Roubini’s other points.  He states that we should “expect a big fight about entitlements, and a series of little fights over tax reform: should the US introduce a value added tax? A flat tax? Higher (or lower) income taxes? A carbon tax? Should we close corporate tax loopholes to raise more revenue? It’ll soon get messy.”  Entitlements indeed form an ideological pivot between the Republicans and the Democrats, but as Roubini states later on in his piece, both parties want to maintain them as they are popular with their voter base. So how to pay for them on an ongoing basis?  Closing corporate tax loopholes would be a good start, and if I was a Democratic strategist, I would suggest that the next sequester should include closing those corporate tax loopholes.  A flat tax, and a VAT, while academically appealing will not be acceptable in terms of a compromise, so I doubt would be part of any negotiation or sequester. 

There is a reason that Roubini is called Dr. Doom.  It’s because he always assumes the worst scenario, and in recent years, he has been right.  But cycles are cycles, and we are now in an upturn, albeit a shallow one, so doom and gloom is unlikely to be the correct scenario.

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