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Economists: Senate Budget Pact Would Slow Economic Growth, Not Stop It

Tuesday, 01 January 2013 09:35 AM

The budget deal passed by the Senate probably would crimp the U.S. economic recovery without stopping it.

The elimination of a 2 percent payroll tax cut, coupled with higher income taxes on the wealthy, will help reduce growth in the first quarter to 1 percent, from 3.1 percent in 2012’s third quarter, the latest data available, according to economists at JPMorgan Chase & Co. and Bank of America Corp. 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 U.S. economist for JPMorgan Chase in New York, said of the fiscal pact that the Senate approved early Tuesday, sending it to the House of Representatives. “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 U.S. will make limited progress in reducing unemployment in 2013, according to projections by Ethan Harris, co-head of global economic research for Bank of America in New York. He sees the jobless rate falling to 7.5 percent in the fourth quarter of 2013 from 7.7 percent in November 2012.

Jobless Benefits

The agreement forged in talks between Vice President Joe Biden and Senate Minority Leader Mitch McConnell, a Kentucky Republican, would avert some, though not all, of more than $600 billion in automatic tax increases and spending cuts slated to take effect this year. Under the accord, passed by the Senate early Tuesday, households making less than $450,000 per year would be spared an income tax rate increase. And the unemployed would still be eligible for extended jobless benefits.

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

The deal faces an uncertain fate in the Republican-controlled House. House Speaker John Boehner of Ohio said Monday night the chamber would consider any budget measure passed by the Senate. “Decisions about whether the House will seek to accept or promptly amend the measure will not be made until House members -- and the American people -- have been able to review the legislation,” Boehner said in a statement.

Even if the House passes the bill, the agreement won’t mean the end of budget brinksmanship, Andrew Laperriere, senior managing director for ISI Group in Washington, said in a report Monday to clients.

Debt Ceiling

The U.S. has hit its $16.4 trillion debt limit, forcing the Treasury Department to take what it called “extraordinary measures” to keep funding the government for now.

The Treasury probably will exhaust such measures by late February or early March, setting up another confrontation between President Barack Obama and congressional Republicans, according to Laperriere, who spent eight years working on Capitol Hill before joining ISI in 1999.

The stock market bounded ahead Monday as lawmakers looked increasingly likely to reach agreement on the budget. The Standard & Poor’s 500 Index rose 1.7 percent to 1,426.19 at 4 p.m. in New York, bringing the gain for the year to 13 percent.

The biggest hit to the economy from the fiscal package probably will 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 through 2012. He reckons that its elimination will slow growth by just over a half percentage point this year by taking $125 billion out of consumers’ pockets.

‘Meaningful Impact’

It “would have a meaningful impact because it hits everybody,” said Michael Gapen, a New York-based senior economist at Barclays Plc. “You’d see it in the first quarter, and consumption would ratchet down.”

Higher taxes on the wealthy, in contrast, won’t have that much of an effect because top earners tend to save more of their income rather than spend it, he added.

Possible federal spending cuts would reduce economic growth by more than a half percentage point if they eventually are implemented, based on estimates by Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. Defense companies such as Northrop Grumman Corp. and Lockheed Martin Corp. could be particularly hard hit.

The deal would prevent automatic spending cuts from taking effect for two months, Senate Republicans told reporters.

Resilient Recovery

The recovery should prove resilient in the face of government belt-tightening because of the progress that the private sector in rebounding from the 2007-2009 recession, said Bank of America’s Harris.

“Both the housing market and the banking sector have healed significantly,” he said.

Residential real estate, which collapsed and helped trigger the 18-month economic downturn that ended in June 2009, is picking up. Existing homes sold at their strongest pace in more than two years in November and building permits reached a four-year high. Companies including Toll Brothers Inc. and KB Home are competing for buildable lots and raising prices.

“We’ve seen a virtuous cycle building in housing,” said Terry Sheehan, an economic analyst at Stone & McCarthy Research in Princeton, New Jersey.

Bank Profits

Banks are bouncing back as well, with profits in the third quarter the highest in six years, according to the Federal Deposit Insurance Corp. in Washington.

The number of lenders on FDIC’s confidential list of so- called problem banks -- those deemed to be at greater risk of collapse -- fell from 732 in the second quarter to 694 in the third, the smallest number since a peak of 888 after the financial crisis.

Another encouraging sign: The job market has held up even in the face of concerns about the possibility of higher taxes and government spending cuts in 2013. Payroll gains this year through November averaged about 151,000 a month compared with 147,000 in the same period of 2011.

Labor Department figures due Jan. 4 may show employers added 150,000 jobs in December, about the same pace as the prior month, according to the median forecast of economists surveyed by Bloomberg.

“Underneath the fiscal drama is an improving economy,” said Ryan Sweet, a senior economist at Moody’s Analytics. “The fiscal drag will take some wind out of it but once there is more clarity, we can expect stronger growth.”

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The budget deal passed by the Senate probably would crimp the U.S. economic recovery without stopping it.
Tuesday, 01 January 2013 09:35 AM
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