Fiscal Cliff

US fiscal cliff deal will hit growth, say economists

Expansion predicted to slow to 1 per cent if last-minute budget deal becomes law

PUBLISHED : Wednesday, 02 January, 2013, 12:00am
UPDATED : Wednesday, 02 January, 2013, 4:24am

The budget deal struck by the White House and US Senate Republican leaders, if it becomes law, would probably slow the US economic recovery without stopping it.

The elimination of a 2 per cent payroll tax cut, coupled with higher income taxes on the wealthy, will help reduce growth in the first quarter to 1 per cent, from 3.1 per cent in last year's third quarter, the latest data available, according to economists at JP Morgan Chase and Bank of America. The expansion will strengthen later in the year as the housing market continues to rebound, they forecast.

"It's going to definitely present a headwind for the economy," Michael Feroli, chief US economist for JP Morgan Chase in New York, said of the fiscal pact that the Senate voted on early yesterday. "We're looking for a downdraft in growth in the first half of the year, with the economy coming back in the second."

The first-half slowdown will mean that the US will make limited progress in reducing unemployment this year, according to projections by Ethan Harris, co-head of global economic research for Bank of America.

The agreement forged in talks between Vice-President Joe Biden and Senate Republican leader Mitch McConnell would avert some, though not all, of more than US$600 billion in automatic tax increases and spending cuts due to take effect this year. Under the accord, households making less than US$450,000 per year would be spared an income tax rate increase.

Payroll taxes would rise to 6.2 per cent from 4.2 per cent last year. And the wealthy would see an increase in their top income tax rate, to 39.6 per cent from 35 per cent.

The deal faces an uncertain fate in the Republican-controlled House of Representatives.

The biggest hit to the economy from the fiscal package will probably come from the expiration of the payroll tax cut, Feroli said. The payroll tax cut was designed as a temporary measure to boost the economy in 2011 and then was extended until the end of last year. He reckons that its elimination will slow economic growth by just over half a percentage point this year by taking US$125 billion out of consumers' pockets.

Higher taxes on the wealthy, in contrast, will not have that much effect, because top earners tend to save more of their income rather than spend it, he said.