Understanding the US fiscal cliff

We’ve heard so much about the United States’ impending “fiscal cliff” in recent weeks, and the harm it could inflict well beyond the American economy. Here at home, there is so much optimism on the outlook for the Philippine economy with its surprising growth performance and a general upswing in business confidence due to perceived governance improvements. I suspect that few Filipinos cared much about this issue that was prominent in the global news through the holidays; probably even fewer understood it at all. What is this fiscal cliff all about anyway? How does it affect us Filipinos?

The “fiscal cliff” refers to how the end of 2012 would have triggered a double whammy on the American economy: dramatic tax hikes and a hefty drop in government spending. This is because several time-bound tax reductions and spending increases provided by law were to expire last Dec. 31, leading to this double-edged hit. Expiring tax provisions include $156 billion worth of tax cuts enacted in 2001 and 2003 under President George W. Bush, a 2-percent payroll tax holiday worth $125 billion, a temporary reduction in the Alternative Minimum Tax (AMT) worth $88 billion, and a few others. All these were to lapse by Jan. 1. The result? Nearly half a trillion dollars in tax hikes!

And there is more. Five taxes enacted as part of the “Obamacare” law also took effect on Jan. 1. Emergency unemployment compensation worth $40 billion introduced during President Obama’s first term was also set to expire at the end of 2012. On the expenditure side, some $11 billion in fiscal stimulus spending instituted in 2008 to fight global recession then was to end as well. Some $109 billion in forced automatic budget cuts would have also been activated with the failure of the US Congress budget “supercommittee” to reach consensus on budget reductions.

Basic macroeconomics holds that increased taxes and reduced government spending, whether individually or in combination, would depress the economy. This is because higher taxes means less money left in people’s pockets to spend, thereby lowering consumer demands for the economy’s goods and services, which in turn would induce production cutbacks. Lower spending by government similarly dampens demand and reduces overall production. Doing the reverse would stimulate more economic activity. Indeed, this was the original rationale for Bush’s tax cuts and Obama’s “fiscal stimulus” government spending, both of which were time-bound, being extraordinary measures taken then.

The impending tax increases cum spending cuts represent more than $600 billion of combined reduction in consumer and government spending, not counting the multiplier effects that would further magnify the resulting drop in US gross domestic product (GDP). With consumer and government spending together accounting for 90 percent of overall US GDP, this would push their economy into a steep fall (as in falling off a cliff) and yet another round of recession. Estimates place the expected drop in US GDP to be induced by reduced consumer and government spending at no less than 4 percent.

It was thus welcome news that the US Congress reached a compromise agreement to avert falling off the cliff on Jan. 1—and surging stock markets all over the world reflected a collective sigh of relief. And yet, all that was really achieved was yet another Band-Aid solution that pushed back the day of reckoning anew. More permanent solutions have yet to be agreed upon, and there are wide disagreements between Democrats and Republicans on the issue. In fact, the compromise solution does not avoid pain altogether; it simply turned the cliff into a downhill slope. The Tax Policy Center estimates that most American households will still see their taxes rise. According to some analysts, the deal could still dampen 2013’s GDP growth by 1 percentage point.

Where do we Filipinos stand through all this? A weakened US economy should somehow impact on us through our usual economic linkages, particularly via trade, investment, tourism and remittances. Lower US incomes would translate into lower demand for our exports. As of last count, the US accounted for 13.2 percent of our total exports (it had been nearly 40 percent in the 1990s), behind China including Hong Kong with 27.1 percent and Japan with 16.6 percent. Most affected would be electronics, coconut oil and tuna, which are our biggest exports to the United States. Overall, the effect on us could be minimal.

About half of total foreign direct investments in 2012 came from the United States, but this varies widely over the years, with other countries like Japan, Korea, Singapore and European countries also being prominent sources that can take up any slack from a US slowdown. It is also argued that economic difficulties drive US firms to greater outsourcing, leading to a positive effect on our fast-growing business process outsourcing (BPO) sector.

Tourists from the United States were our second largest group (next to Koreans) of visitors in 2012, with around 600,000 or 15.2 percent; that could take a hit too. As for remittances, the data show that a major portion of Filipino migrants in the United States work in the recession-proof health care industry (about one-third of Filipino women migrants there) and other recession-resilient jobs like management, administrative support, finance and services. Past experience has shown that remittances continued to grow through major crises the world had seen in the last 15 years.

With or without the US compromise package, we would suffer a hit. Still, I’d say it’s probably not enough to negate the internally induced vigor our economy is poised to show in 2013.

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