Since the global economic crisis began, the United States has avoided the path of austerity so hastily pursued by the UK and the eurozone. Subsequent events have vindicated its decision to do so. While Britain and the euro area have fallen back into recession, the US has experienced a sustained recovery. Its economy has grown for 13 consecutive quarters, with output now 2.2 per cent above its pre-recession peak, and unemployment has fallen to a four-year low of 7.7 per cent.
Failure to reach agreement on the “fiscal cliff”, the term coined by Federal Reserve chairman Ben Bernanke to describe the $607bn of tax rises and spending cuts which were due to take effect from 1 January, would have threatened almost all of this progress. The US Congressional Budget Office estimated that the total fiscal contraction of 4 per cent of GDP would cause the economy to shrink by 0.5 per cent this year and increase unemployment to 9.1 per cent. With its national debt now totalling $16.3trn (103 per cent of GDP), the US government needs a better balance between what it spends and what it earns, but such extreme austerity would be self-defeating.
It should have been possible for Barack Obama and Congress to reach agreement months ago on a deal that allowed for responsible deficit reduction while also protecting the economic recovery. That it was not was largely due to the intransigence of the Republicans, who grandstanded as fiscal conservatives while refusing to countenance tax rises on even the wealthiest Americans.
The deal eventually struck by Mr Obama and Senate Republicans in the final hours of 2012 was most notable for its limitations. Having won re-election on a pledge to raise income tax from 35 per cent to 39.6 per cent on those earning over $200,000 a year, while retaining the Bush-era tax cuts for other income groups, Mr Obama was forced to accept a significantly higher threshold of $400,000. At the same time, he agreed to the repeal of his administration’s reduction in payroll taxes (the US equivalent of National Insurance), meaning a higher tax bill for the low and middle income groups he aimed to protect. The return of the rate to 6.2 per cent from its current level of 4.2 per cent will cost a household earning the median income of $50,000 an extra $1,000 a year.
The wealthiest Americans, by contrast, retain most of the tax perks introduced by the Bush administration. Capital gains and dividends above $450,000 will now be taxed at 20 per cent, rather than 15 per cent, but this is still well below the 39.6 per cent rate seen during the Clinton administration, which ensured capital gains were treated in the same way as ordinary income. The top rate of inheritance tax will rise from 35 per cent to 40 per cent but the threshold remains an exceptional $5m, locking in favourable treatment for most of the country’s millionaires.
Both as a matter of social justice and economic policy, it is important for the richest, who are more likely to save, rather than spend, any tax giveaway, to bear the burden of austerity. But owing to the dogmatic stance of the Republicans, Mr Obama has sacrificed hundreds of billions in potential revenue. The danger remains that the US will seek to achieve debt reduction through dramatic spending cuts of $110bn, which the agreement reached this week simply postpones for two months. Once again, in a cynical game of chicken, the Republicans intend to use the forthcoming vote on raising the US debt ceiling (hitherto a formality under Republican and Democrat presidents alike) to extort large cuts to social security and Medicare. The fiscal cliff has not been averted; it has merely been postponed.
In his autumn statement last month, George Osborne rightly cited the uncertainty in the US as a threat to recovery of the British economy. Yet having pushed the UK off its own fiscal cliff in 2010, the Chancellor has little right to lecture political leaders across the Atlantic. Even with Britain in danger of an unprecedented triple-dip recession, there will be no let up in austerity this year. The decision to increase out-of-work and in-work benefits by just 1 per cent, below the rate of inflation, will further squeeze consumers’ spending power and reduce aggregate demand. In the case of the US, the hope remains that wiser minds will prevail and an unnecessary slide into recession will be prevented. But for the UK, the wrangling in Washington is an unhappy reminder that its fate was settled long ago.