Last Thursday saw the start of negotiations in Washington on a deficit-reduction agreement to be passed by year-end. If struck, a deal would avert the much-feared fiscal cliff – $500bn in annual tax increases and spending cuts, which is set to begin in four weeks. Despite the immediacy of this threat, there is widespread fear that the negotiations may fail, triggering this huge fiscal contraction and pushing the fragile US economy back into recession.
Fortunately this fear is misplaced because America will not go over the fiscal cliff and stay there. However bumpy the talks, a deficit agreement will probably emerge just before or a week or two after the year-end deadline. The agreement will reduce deficits without injuring economic growth. And it will boost consumer and business confidence.
Why this relative optimism? First, in the presidential election that just ended, taxes were debated every day. Not only did President Barack Obama win the election decisively but exit polls indicated 70 per cent support for his position on taxes, namely that high earners should pay more, but the middle class should not. In other words, the people have spoken on this issue and members of Congress cannot ignore that without jeopardising their own positions.