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Looming 'fiscal cliff' is hurting US economy now, economists warn

Memo to Washington: Don't wait until after the election to resolve the 'fiscal cliff' facing the nation on Dec. 31. Uncertainty about taxes and spending is already harming the US economy, risking a new recession, some economists say.

By Staff writer / August 17, 2012

Senate minority leader Mitch McConnell (R) of Kentucky gestures during a July 24 news conference on Capitol Hill in Washington. Both parties accuse the other of threatening to throw the nation over a 'fiscal cliff' on Dec. 31.

J. Scott Applewhite/AP/File


Look out below. Despite some positive signals from the US economy lately, a scheduled increase in taxes next year may pose an immediate risk of slowing growth.

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The challenge is this: When businesses see a high level of uncertainty about the policy climate – in this case whether taxes will go up or not – they may operate in a wait-and-see mode that holds back their hiring and investing decisions.

Some economists say that's exactly what is already happening – and that it's likely to damage the economy in coming months, as the nation awaits action from Congress.

This view runs counter to the media chatter in the current political campaign. Many pundits talk about the "fiscal cliff," which includes the expiration of tax cuts on Dec. 31, as if the potential for economic harm would begin on that date. And they expect that Congress and the president will do something to soften the blow through legislation after the November election, because otherwise the negative shock of tax hikes plus billions in scheduled spending cuts could tip the US back into recession.

The problem is, there's no telling exactly what will happen or when, given Congress's current gridlock and the wide divergence in tax proposals between President Obama and his rival, Mitt Romney.

"Those two candidates are miles apart," says Steven Davis, a University of Chicago economist. "I cannot think of another time in recent decades when there appeared to be that much uncertainty about the tax treatment of business income riding on an election."

The uncertainty surrounding the fiscal cliff and other looming tax decisions, he says, is having an impact on businesses today.

It's showing up in surveys of businesses, including in the informal "beige book" interviews conducted by the Federal Reserve, Mr. Davis says. He also cites recent research, which he conducted with economists Scott Baker and Nicholas Bloom of Stanford University, on the link between policy uncertainty and economic growth. The researchers drew on several data sources to create an index of uncertainty, and found that a spike in such doubt often foreshadows weakness in the economy.

"When policy uncertainty levels are high, that does not bode well for future economic performance," Davis says. In his view, a new recession is possible, with risk coming from events in Europe as well as the US.

The fiscal cliff, by some estimates, could suck about 5 percentage points out of gross domestic product in 2013, if various tax cuts expire as scheduled, alongside some spending cuts.

Many forecasters share Davis's concern, at least to some degree. 


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