CQ TODAY ONLINE NEWS
April 23, 2012 – 10:13 p.m.
Fiscal Uncertainty Already Rattling Investors
By Joseph J. Schatz, CQ Staff
The potential for a new round of budget brinkmanship at year’s end is heightening attention in financial circles, where there is growing concern about the uncertainty and economic fallout from the fiscal negotiations expected to follow the Nov. 6 elections.
Lawmakers have all but conceded that nothing will be done before the presidential and congressional elections to address changes in the tax code or to make any changes to a sequester process that will lead to $98 billion in automatic spending cuts.
The results of the elections will dictate some of the scenarios that could unfold in a lame-duck session. But so will the state of the economy, given that tax receipts and federal spending over the next several months will determine when the Treasury Department reaches its statutory borrowing limit, requiring Congress to raise the debt ceiling. That is expected to happen sometime between the election and the end of the year.
Financial industry analysts say the potential collision of significant fiscal matters in the highly confrontational environment in Washington may unsettle investors ahead of time.
In an analysis earlier this month, Morgan Stanley analyst David Greenlaw noted an expiration of the Bush administration tax cuts “would entail significant confusion — and potentially represent an important headwind for both the overall economy and the financial markets.”
“The economic risks associated with policy uncertainty, as well as the potential for a meaningful tightening on the fiscal side, may be magnified because the Fed’s ability to provide some cushion via monetary stimulus seems to be quite limited with the funds rate at the zero bound,” he said.
Some forecasters expect the economy to feel the impact from delay and uncertainty in advance of the election. Tom Porcelli at RBC Capital Markets, for instance, is forecasting a weak fourth quarter “that will be subject to major confidence headwinds from the uncertain presidential election, a revisiting of the debt ceiling and the final approach into the fiscal cliff,” he said in an April 19 email.
When exactly lawmakers have to address the debt ceiling may influence how quickly they have to confront a post-election deal to extend tax rates or overhaul the tax code and reorder the spending sequester. The last debt ceiling debate triggered a months-long stalemate on Capitol Hill that left all sides politically tarnished. It also led Standard and Poor’s in August to lower the U.S. credit rating, sending shudders through many government circles even though the action had little real effect.
Under the current law, the effect of spending cuts and tax changes could total about $600 billion, and estimates of the impact on economic growth generally range between 3 percent and 5 percent.
Still, Geithner said lawmakers should reduce the uncertainty by not withdrawing fiscal stimulus too quickly, by recognizing the president’s tax increases would only involve the top 2 percent of earners and by signaling “Congress will pass the debt limit without all the drama and politics and damage that Republicans and Congress imposed on the country last summer.”
A status quo election, with Democrats keeping the White House and the Senate while Republicans retain control of the House, may increase the odds of a relatively quick deal. That may involve a rewrite of the tax code, although it might still spark a contentious debate over temporarily extending the expiring tax cuts, if only for a few months, to give tax writers time to fashion a deal.
Fiscal Uncertainty Already Rattling Investors
Lawmakers, lobbyists and Wall Street analysts say publicly, and privately, that they see more short-term uncertainty stemming from change in control of the White House. Control of the Senate will play a role, but to a lesser degree, since even a new Republican majority likely would have only small margin of control.
“There are, like, three different permutations that I think we could end up with,” says Sen.
Meanwhile, there is talk circulating in Washington of short-term stopgaps ranging from a couple of months to a full year.
G. William Hoagland, a former top Senate GOP budget and leadership aide who is now vice president of public policy with Cigna Corp., says an agreement on a six-month measure postponing the expiration of the tax cuts, temporarily raising the debt ceiling and also delaying the sequester — while offsetting it with other spending reductions — could “put a little more certainty in the markets.”
The state of the economy is likely to affect what lawmakers decide, regardless of the election’s outcome.
Lawmakers will have to consider whether changes to the sequester might undermine confidence among investors that the U.S. government will address the longer-term debt challenge. Those automatic spending cuts, which could be significant at first and may coincide with tax increases, could undermine economic growth next year.
A slowing economy this year might change that equation, adding urgency for an agreement. But an improved economy that sends greater tax receipts flowing into the Treasury, reducing the federal deficit, could take some pressure off lawmakers to reduce the deficit further through lawmaking.
Despite all the talk of a so-called grand bargain addressing both spending and revenues, lawmakers have not shown a great desire to dive into the specifics of long-term deficit reduction. Even the general disdain for the sequester, for instance, has not pushed members on both sides of the aisle to undertake a bipartisan deal.
Still, Democrats hope the president’s election year focus on economic fairness means Obama will not let the current tax rates for upper-income earners continue regardless of the election outcome.
“I think that the president will not change direction,” says Rep.