Macquarie Research, The Visible Hand- The real fiscal battle is just starting

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The Visible Hand
The real fiscal battle is just starting
Event
 A compromise agreement in the US looks like it will allow the debt ceiling to
be raised.
Impact
 Stabilising the government debt burden in the US will be easier than in a lot of
other countries. While the compromise does not include any revenue
increases, tax hikes from the start of 2013 will amplify the impact of the
spending cuts.
 That is, of course, if the US Congress does not legislate to extend lower taxes
yet again. And this is potentially going to be one of the most important political
battles until the elections of November 2012.
 The issue is not just fiscal solvency. Rather, there is going to be sharply
divided views on the appropriate size of government and the winner of this
ideological split could set the path of the US economy for many years.
Analysis
 After much huffing and puffing, the US Congress and President have
managed to put together a compromise agreement to lift the debt ceiling.
 The legislation puts caps on discretionary spending through to 2021. Lower
spending in 2012 is minimal and the cutbacks really only start to bite from
2013.
 One of the surprises is the cutback in defence spending which is large by US
standards. The hit to other sectors will partly depend on the recommendations
of the Joint Select Committee on Deficit Reduction which has to find $1.5
trillion in savings over ten years.
 On the basis of the legislation the Congressional Budget Office (CBO)
believes that the combination of the spending caps and the target of the Joint
Committee would reduce the federal budget deficit by $2.1 trillion over 2012-
2021.
 This is by no means the end of fiscal contraction. While this agreement does
not increase revenue, there is an automatic tax increase coming from 31
December 2012 even if the Congress does nothing.
 Income tax rates that were cut during the administration of George W Bush
were extended late last year until the end of 2012. Other concessions, such
as relief from the provisions of Alternative Minimum Tax, were also extended
and are due to expire at the same time.
 If the Congress does nothing then US tax rates will rise from the start of 2013.
And the increase in revenue over the following ten years would be enormous.