Thursday, November 04, 2010

Policies set to clash in Washington

Business Times - 05 Nov 2010

PERPESTIVE
Policies set to clash in Washington

A potentially gridlocked legislative process could retard the economic recovery and hurt business

By LEON HADAR
WASHINGTON CORRESPONDENT

ON THE same day that the US Federal Reserve launched a new round of quantitative easing, as it announced its plan to buy US$600 billion worth of government securities through the middle of next year, President Barack Obama and Congressional leaders were facing their first post-midterms economic-policy challenge: Should they extend the tax cuts that were passed under president George W Bush and that are set to expire at the end of the year?

The newly elected Congress where Republicans will control the House of Representatives and increase their numbers in the Senate will not convene until January next year.

This timeline is forcing the current Democratic-controlled Congress and the White House to make a difficult choice and demonstrate the way that a potentially gridlocked legislative process - a Democratic president vs a Republican House - could retard the economic recovery and hurt business.

There is a complete agreement among officials and lawmakers in Washington that allowing the tax cuts to expire would diminish Americans' disposable incomes and reduce economic growth, bringing the current sluggish economic recovery to a complete halt and perhaps even trigger a new recession.

But a permanent extension of the tax cuts will increase the ballooning debt of the federal government since neither the White House nor Congress will be ready to fund these tax cuts by cutting other federal programmes.

Complicating matters is the fact that Mr Obama and the Democrats insist that Congress should extend the tax cuts only to middle-class households but not to the wealthy, while Republicans want to permanently extend them to everyone, including to those in the top income bracket.

The two sides will therefore have to reach a compromise over the issue during the so-called 'lame duck' session of the current Congress. Although the Republicans are not in control of the lame-duck Congress, their mid-term victories this week is providing them with added political leverage to win a compromise on extending the tax cuts that is more in line with their position.

One of the ideas being considered is the extension of the entire package of the tax cuts, but only for another year or two, by then the economic recovery could be in full-swing - when the White House and Congress would try to negotiate a permanent extension.

During his first press conference after the mid-term elections, President Obama made it clear that he wanted to extend the tax cuts to middle-class households and that he was ready to negotiate the issue with the Republican leaders.

Indeed, Democrats and Republicans recognise that a failure to reach a deal on the tax cuts and allowing them to expire would alarm investors and send new shockwaves through the financial markets.

But resolving the issue of the tax cuts is going to be probably much less difficult than tackling the next big item on the agenda: fiscal policy. And this is where the Fed's policy of quantitative easing for the second time since the crash of 2008, known as QE2, cuts across the gridlock in Washington.

After all, even the most bullish observers agree that the effect of the new round of quantitative easing on the economy would be limited at best. Many businesses are already sitting on large amounts of cash which they borrowed at low rates during the QE1.

Yet these businesses are doing very little hiring as they wait for sales to increase. And that is not happening since consumers are not going to spend a lot of money until unemployment starts falling.

Under these circumstances, it's not clear whether the QE2 is going to make a lot of difference.

Indeed, one of the reasons why the QE1 was effective had to do with the impact of the aggressive fiscal policies being pursued by the Obama administration in the form of the huge economic stimulus package and the bank bailouts that helped create the conditions for the end of the recession.

But the new contingent of the Tea Party-backed Republican lawmakers that will arrive in Washington next year have denounced the economic stimulus and pledged to block new ones. That, indeed, was the central theme of the winning Republican election campaign.

But then, without new rounds of the economic stimulus package, any new round of quantitative easing could prove to be ineffective.

These political and economic realities pose an interesting dilemma for Corporate America whose members have been rooting for Republican wins this week - confident that the pro-business and small-government Republicans are going to promote an agenda of less taxes and less regulations, and less spending. Which means that gridlock could be good for business.

But the same economic small-government philosophy driving their policies also explains why the same Republicans will try to derail any new economic stimulus packages and is putting a downward pressure on the economic recovery.

Which means that gridlock could also be bad for business. Which raises the following questions: Will Corporate America press their Republican allies to work with the Democrats and support a more activist fiscal policy?

And how will the tea partiers react if the Republican leaders move in that direction? Stay tuned.

btnews@sph.com.sg

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