Analysis: Economy would dodge bullet for now under fiscal deal

U.S. Senate Minority Leader Mitch McConnell (C) departs the senate floor with an aide after a senate vote in the early morning hours at the U.S. Capitol in Washington January 1, 2013.

Credit: Reuters/Jonathan Ernst

By Jason Lange

WASHINGTON | Tue Jan 1, 2013 7:26am EST

WASHINGTON (Reuters) - A deal worked out by Senate leaders to avoid the "fiscal cliff" was far from any "grand bargain" of deficit reduction measures.

But if approved by the House of Representatives, it could help the country steer clear of recession, although enough austerity would remain in place to likely keep the economy growing at a lackluster pace.

The Senate approved a last-minute deal early Tuesday morning to scale back $600 billion in scheduled tax hikes and government spending cuts that economists widely agree would tip the economy into recession.

The deal would hike taxes permanently for household incomes over $450,000 a year, but keep existing lower rates in force for everyone else.

It would make permanent the alternative minimum tax "patch" that was set to expire, protecting middle-income Americans from being taxed as if they were rich.

Scheduled cuts in defense and non-defense spending were simply postponed for two months.

Economists said that if the emerging package were to become law, it would represent at least a temporary reprieve for the economy. "This keeps us out of recession for now," said Menzie Chinn, an economist at the University of Wisconsin-Madison.

The contours of the deal suggest that roughly one-third of the scheduled fiscal tightening could still take place, said Brett Ryan, an economist at Deutsche Bank in New York.

That is in line with what many financial firms on Wall Street and around the world have been expecting, suggesting forecasts for economic growth of around 1.9 percent for 2013 would likely hold.

At midnight Monday, low tax rates enacted under then-President George W. Bush in 2001 and 2003 expired. If the House agrees with the Senate - and there remained considerable doubt on that score - the new rates would be extended retroactively.

Otherwise, together with other planned tax hikes, the average household would pay an estimated $3,500 more in taxes, according to the Tax Policy Center, a Washington think tank. Budget experts expect the economy would take a hit as families cut back on spending.

Provisions in the Senate bill would avoid scheduled cuts to jobless benefits and to payments to doctors under a federal health insurance program.

AUSTERITY'S BITE

Like the consensus of economists from Wall Street and beyond, Deutsche Bank has been forecasting enough fiscal drag to hold back growth to roughly 1.9 percent in 2013. Ryan said the details of the deal appeared to support that forecast.

That would be much better than the 0.5 percent contraction predicted by the Congressional Budget Office if the entirety of the fiscal cliff took hold, but it would fall short of what is needed to quickly heal the labor market, which is still smarting from the 2007-09 recession.

"We continue to anticipate a significant economic slowdown at the start of the year in response to fiscal drag and a contentious fiscal debate," economists at Nomura said in a research note.

In particular, analysts say financial markets are likely to remain on tenterhooks until Congress raises the nation's $16.4 trillion debt ceiling, which the U.S. Treasury confirmed had been reached on Monday.

While the Bush tax cuts would be made permanent for many Americans under the budget deal, a two-year-long payroll tax holiday enacted to give the economy an extra boost would expire. The Tax Policy Center estimates this could push the average household tax bill up by about $700 next year.

The suspension of spending cuts sets up a smaller fiscal cliff later in the year which still could be enough to send the economy into recession, said Chinn.

He warned that ongoing worries about the possibility of recession could keep businesses from investing, which would hinder economic growth.

"You retain the uncertainty," Chinn said.

(Reporting by Jason Lange; Editing by Eric Walsh)

(This story was refiled to remove extraneous punctuation in the first paragraph)

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Mandel: Gingrich tax plan would increase the impact of globalization on Americans

By Michael Mandel Dec 13 2011, 10:50 AM ET Eliminating investment taxes, as the presidential hopeful has proposed, would be a needless gift to investors and executives profiting off the gains from outsourcing and "global income"

Reuters

"It starts very simply: Taxes, lower taxes."

That was the first line of Newt Gingrich's explanation of how he would create jobs, given at the December 10 Republican debate in Iowa. Gingrich talked about his desire to end the capital gains tax and cut the corporate income tax to 12.5%. In addition, Gingrich has proposed a 15% flat tax as an option for all Americans, going further than the 20% flat tax advocated by Rick Perry.

On one level, Gingrich's intense focus on lower taxes fits current dogma in the Republican party, which puts tax cuts above almost everything else. He is playing to the conservative base, as a way of counteracting some of his other personal liabilities.

In Newt's plan, someone making $40,000 could pay a higher rate than a millionaire

If enacted in their entirety, Gingrich's proposed changes would turn the U.S. tax system from progressive to regressive. Someone earning $40,000 in wages could pay a higher tax rate than another person who made $400,000 a year in capital gains.

This shift from progressive to regressive is not acceptable, of course. The tax system should be a tool for reducing the stresses of inequality in the economy, not increasing it. That's especially true now, coming out of such a devastating recession where so many American are unemployed or underemployed.

But these tax cuts, which lie at the heart of the Gingrich program, would have another striking implication as well, which has not yet been remarked on. He is targeting precisely those taxes -- like the corporate income tax and capital gains tax -- that capture the gains from globalization. In other words, Gingrich is waging war on Washington's ability to tax "globalized" income, which is likely to grow faster than domestic income for the foreseeable future.

What do I mean by "globalized" income? By my definition, globalized income means funds that come directly or indirectly from the operations of U.S. companies in the global economy. The most obvious example of globalized income is the money that companies report as "rest-of-world" or foreign profits. Today, the Bureau of Economic Analysis reports that "rest-of-world" profits are running at a $450 billion annual rate, small potatoes compared to a $15 trillion economy.

However, the category of globalized income includes a lot more than foreign profits. For example, suppose that a U.S-based company is highly profitable in Asia. Even if those profits are not repatriated, the company's share price is likely to rise. If an American stockholder sells those shares and collects a $5 million capital gain, that gain is reported as domestic income. But in fact, it's due purely to the operations of that company overseas. Similarly, when the CEO of that company cashes his or her stock options, it's the same thing. The stock option gains get reported as domestic income, even though they are directly connected to the company's operations overseas.

Here's another example. Suppose that a U.S. furniture retailer switches suppliers. Instead of buying from a domestic manufacturer, they now get their furniture from a cheaper foreign manufacturer. Because of this outsourcing, corporate profits rise, and the CEO gets a big bonus. To the government statisticians, that bonus looks like pure domestic wage and salary income. However, it flows purely out of the company's ability to take advantage of the cheaper prices on the global market place.

Ordinary workers generally don't have globalized income--their wages and salaries are purely domestic, unless they happen to be working directly on exports. Globalized income flows to those people whose incomes rise when the company as a whole does well--shareholders and high-ranking executives . And those are the people who are affected by capital gain taxes, corporate income taxes, and progressive tax rates on high earners.

And here's where we get back to Newt Gingrich and his plan. The U.S. population is being separated into two groups: Those people who are benefiting from the increased globalization of the U.S. economy in their work lives, and those who are not. This is the big divide in the economy right now--and we don't need a tax proposal that just widens the gap.

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What would happen if an asteroid hit U.S. banks?

A member of the Occupy Wall Street movement shows his sign as he protests on 5th Avenue while marching through the upper east side of New York October 11, 2011.

Credit: Reuters/Shannon Stapleton

By Stella Dawson, U.S. Economics Editor

WASHINGTON | Wed Nov 23, 2011 5:03pm EST

WASHINGTON (Reuters) - Ever wondered what the U.S. economy might look like should there be another Lehman Brothers-style bank collapse? Well, it would not be pretty.

Unemployment could jump to 13 percent, recalling the breadlines of the 1930s. The Dow Jones industrials might plunge 50 percent to 5,668, a level last reached before the dot.com boom in the mid-1990s. At the depths of a brutal year-long recession, output might shrink at an 8 percent annualized rate, wiping out two whole years worth of growth.

Anyone lucky enough to have a job or cash left after the carnage could snap up a home at November 2000 prices.

This dire picture is what the Federal Reserve wants U.S. banks to imagine when they test their balance sheets for resiliency against a major economic shock.

So tough is the test that Karen Petrou, managing partner of Federal Financial Analytics, quipped: "The only adverse event the Fed left out is a direct asteroid strike on a major banking center."

It sounds shocking. But it's actually similar to the firestorm that swept through the United States after the shock bankruptcy of investment bank Lehman in September 2008, which ushered in the worst recession since the 1930s.

Next time around, however, damage could be even worse because the U.S. economy would enter in a weakened state. It is still healing from the last recession and a second blow could be crippling.

Few economists predict a U.S. recession, though uncertainty is rampant. A Reuters poll earlier this month put the risk at 25 percent, down from 30 percent the prior month, and recent U.S. economic data has improved.

The Fed last year began running banks through annual "stress tests" to measure how their balance sheets and capital buffers would cope with conditions in the consensus economic outlook, plus a major shock. On Tuesday it announced details of how it will conduct its round for 2012 release.

The latest stress test is tougher than the last -- little wonder, noted Nomorua Equity Research, given Europe sliding back into recession, China slowing, financial markets in turmoil over the euro-zone sovereign debt crisis and an uncertain U.S. fiscal picture.

But Richard Bove, a banking analyst at Rochdale Securities, says it is irresponsible to put 31 U.S. banks through a worst-case scenario. A stress test this tough risks forcing banks to prepare for the worst, possibly creating what regulators fear.

"They are going to dump loans, they are going to stop lending and they are going to put us into the recession that the government wants to know how they will function within.

"This is a really stupid stress test," Bove told Reuters Insider Television. insider.thomsonreuters.com/

Srinivas Thiruvadanthai, director of research at the Jerome Levy Forecasting Center, disagrees. He welcomed the Fed's move, saying it will hasten a shrinkage of bank balance sheets that is much needed to match a slower-growing economy.

NOT FORECASTS

The Fed stated in bold letters several times in its news release on Tuesday that the adverse conditions "are not forecasts but hypothetical scenarios."

But the deep recession the Fed conjures is based upon actual experience of severe recessions, such as 1973-75, 1981-82 and 2007-2009. In fact, the numbers closely mirror the scale of damage from the Lehman bankruptcy, layered upon a weaker baseline.

The Fed also notes risks from overseas.

"An outcome like the supervisory stress scenario, while unlikely, may prevail if the U.S. economy were to experience a recession while at the same time economic activity in other major economies were also to contract significantly," it said.

If the United States were to enter a deep recession in the fourth quarter of this year, the Fed's worst-case scenario envisages the euro zone hit hard, suffering almost two year's of contraction until mid-2013, while output shrinks by a more than 6 percent annualized rate at its depths.

(Additional reporting by Dave Clarke; Editing by Dan Grebler)

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