Obama straps America into economic safety harness to avoid dropping off fiscal cliff

Late last night, the House of Representatives voted in favour of Obama's new budget legislation, which could take the edge off that dreaded 'fiscal cliff'.

by Rebecca Burn-Callander
Last Updated: 19 Aug 2013
Obama and his legislators burned the midnight oil as they thrashed out ways to prevent the fiscal cliff of huge tax rises and swingeing spending cuts from sinking the US economy. They really took it to the wire too. The decision had to be made before the financial markets opened today and the final vote was counted at 2am.

The world breathed a sigh of relief this morning at the news that a new bill, passed by 257 votes to 167, will raise taxes on the wealthy and delay spending cuts for two months to keep the economy on an even keel. This is not a fix-all, explains President Obama, but ‘just one step in the broader effort to strengthen the economy’.

The markets are certainly convinced. London's FTSE 100 alone rose to above 6,000 for the first time in seventeen months. Shares in Germany, France, Italy and Spain all made strong gains of between 2% and 3.2%. Hong Kong rose 2.9% in early trading, while Sydney gained 1.2% and Seoul 1.71%. When America’s cheered, we’re all happy, it seems.

So what’s actually being done? Well, inheritance tax will increase by 5% to 40%. Capital taxes are also rising, but falling short of the 39.6% rate that would come into play without this bill. There is some solace for America’s two million unemployed too, who will continue to receive benefits for one more year, while poorer families will receive a five-year extension to the tax credit system, a life-line for many families living below the bread line. But the deal has put the kibosh on the payroll tax holiday: taxes for 160 million Americans will rise from 4.2% to 6.2%.

‘I will sign a law that raises taxes on the wealthiest 2% of Americans... while preventing a middle-class tax hike,’ announced Obama at a White House press conference.

For those unfamiliar with the fiscal cliff situation, here’s a whistle-stop tour of recent US fiscal policy. George W Bush managed to squeeze through a raft of tax cuts during his tenure as President, but only on the understanding that these cuts would expire after two years. That expiry date has just passed. Without Obama’s new bill, the bottom rate of tax would jump immediately from 10% to 15%, and the top rate from 35% to 39.6%. Many economists posit that the resultant pressure on the economy and downturn in consumer spending would send the US into another recession immediately.

Obama has just effectively bought himself a bit more time to get America’s breath-taking budget deficit under control. Over the next two months, Congress must decide on a long-term strategy on spending cuts and tax increases. US law does not allow American debt to pass a prearranged ‘debt ceiling’ – although this was notionally breached at the end of 2012 – treasury secretary Tim Geithner saved the day with some clever deferred accounting. There will be quite the political tug of war over the next few months: Republicans will not accept tax hikes without the Democrats agreeing to deep cuts to Medicare and Social Security.

Given the challenges ahead, the metaphor of the fiscal cliff seems rather simplistic. There is not one single giant obstacle to be scaled and carefully navigated but an entire fiscal Appalachian mountain range. Obama best strap on his hard hat and watch out for falling boulders…

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