The Canberra Times

Keep a lookout for 'fiscal cliff', writes Adam Lockyer

This presidential election was supposed to be fought on the economy. Yet, the ''fiscal cliff'', which is the most immediate and gravest threat to the US economy, was barely mentioned in the three presidential debates.

The fiscal cliff refers to a series of tax increases and spending cuts that are set to take affect on January 1, 2013. Congress' solution to last year's debt ceiling crisis was to plant a time bomb under the US economy. It was hoped that this would motivate both Democrats and Republicans to work together to find a long-term solution to increasing national debt, which is set to reach $US16.4 trillion by the end of the year.

First, $US110 billion in spending cuts will be triggered automatically. The logic of sequestration is that $US55 billion a year will be slashed from the defence and social programs budgets. It is intended to equally hurt Republicans and Democrats and spur co-operation and ultimately a solution.

Second, the expiring of the ''Bush tax cuts'' is set to increase revenue by $US400 billion a year. Instead of being sunk back into the economy, however, it will be used to service the national debt. Although the wealthy benefited the most from the tax cuts, it is estimated that 90 per cent of households will be hit by the taxes' reinstatement.

The Congressional Budget Office estimates that the combination of reduced spending and increased taxes will reduce growth next year by 3.9 per cent. This is more than enough to send the fragile recovery back into recession.

Yet, this is a political story more than an economic one. It has been extensively documented that when Barack Obama took office in 2008, Republicans in Congress sat down to formulate ways to ensure he was a one-term president. This was not surprising. After all, this is precisely the role of the opposition in a democracy. Although the goal was an old one, using the debt ceiling as a weapon was new.

So, how likely is a deal? Nothing can happen before the election. And, after the election, every actor's political calculus changes. Some of these changes are more predictable than others.

Win or lose, President Obama will have to deal with the fiscal cliff. Inauguration day is not until January 20. A defeated ''lame-duck'' Obama will probably simply try to pass the buck to the incoming Romney administration. In this future, Obama will probably try to find a short-term solution before January 1.

Then, mid-next year, we will begin the game again, but this time switching sides. Democrats in Congress will want vengeance. And the Republicans have taught them a way of crippling a president.

A victorious Obama has a different incentive structure. He is likely to pursue brinkmanship. First, he knows that this whole situation was brought on by a Republican strategy to make him a one-term president. Once he has been re-elected, he will serve his final term no matter what. As such, Obama may believe that - with their main objective removed - Republicans will be more likely to deal.

Second, a re-elected Obama wants a medium to long-term solution. He will know that kicking the can down the road will only mean revisiting these same issues later in 2013. He will want to solve these problems early and permanently.

Third, this is probably his best shot at reaching a lasting deal. However narrowly he wins, Obama will have the mandate of a recent electoral victory. In addition, he will have a set of automatic tax rises and spending cuts, which, in their entirety, probably hurt Republicans more than Democrats.

The congressional elections, and particularly the Senate race, will cast their own peculiar light on the impending fiscal cliff. It is unclear, for example, how a senator who loses their seat will behave. Armed with the option to filibuster any bill, a senator has a virtual veto over the passing of legislation. It is foreseeable, for instance, that a Republican senator might reason that it's better to return to the ''real world'' with a clean voting record on rising taxes than to compromise on a solution.

How defeated senators will vote on any bill designed to avoid going over the fiscal cliff is impossible to predict and adds a dangerous element to the coming political engagements. Win or lose, the current Congress will be at the reins until January 3, when the 113rd Congress will be sworn in.

All in all, I think January may be a terrible time for the stockmarket. Obama may well play brinkmanship and we may, for a time, plunge over the fiscal cliff. However, in the long run, this may be the best possible solution as it makes a lasting deal more likely.

This article was originally published by The Canberra Times