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Federal Reserve official: If Congress dawdles, economy will fall 3 percent

Congress must sort out a raft of fiscal issues before Jan. 1, or it will cost the US economy dearly, said New York Federal Reserve President William Dudley.

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“You would like them to defer to you?” asked Time correspondent Mark Halperin. Replied Romney: “Absolutely…. My hope is to be able to come into office with people on both sides of the aisle who are cognizant of the critical nature of what America faces fiscally, what the people of America are facing employment-wise, the failure in our economy that is hurting so many people, and that we’ll see Republicans and Democrats say, OK, well what kind of tax proposals will encourage economic growth? What kind of regulatory reform will encourage economic growth?”

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However, if Congress waits, as Romney is asking, the Internal Revenue Service will be unsure of what income tax withholding rates to publish for 2013. Corporate boards won’t know the tax rates for dividends.

“They need to get this done by the end of September or early October,” warns Pete Davis of Davis Capital Investments, a former economist on the Joint Committee on Taxation, who now advises Wall Street clients.

Mr. Davis says technically the US Treasury can decree that the IRS use a lower withholding rate in anticipation that the issue will get resolved later.  He recalls in 1992, President George H.W. Bush decreed lower withholding rates without any action from Congress to stimulate the economy.  “He put out a pretty good tax cut without any change in the law,” he says.

Davis thinks the warnings from the CBO and the Federal Reserve officials may be starting to have an effect. “Now some people are asking if there is some way to wiggle out of this and avoid the damage,” he says.

However, Congress has to be careful how it does this, he points out. If it does not pay for tax cuts or ignores its own sequestration rules, it risks having the rating agencies downgrade the US credit rating. In August of 2011 after Standard and Poor’s downgraded the US debt from AAA to AA, the Dow Jones Industrial Average sank almost 530 points.

So what is Congress to do? At the Council on Foreign Relations, Dudley said that Congress needs to start with a modest goal of reducing the deficit and then increase the reductions in later years as the economy improves. In addition, he says, any budget deal needs to be credible with bipartisan support so it can be sustained over many years.

If nothing gets done by Congress, Dudley says it could affect monetary policy. “It would have implications for the economic outlook, we would have to take that into consideration,” he said.

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