Is Congress to blame for a downshifting US economy?

Evidence is mounting that the economy is taking a hit because Congress can't – or won't – deal with the 'fiscal cliff' looming at year's end. The fight on Capitol Hill last summer over the national debt limit also took an economic toll. 

Focus

A rising chorus of voices, inside and outside Washington, is warning that political gridlock in Congress is now so severe that it has actually done damage to the economy – and threatens to do a lot more.

President Obama, of course, is the chief "blame Congress" finger-pointer, perhaps to be expected as he fights to win reelection as the economy flails. But plenty of others – Federal Reserve Chairman Ben Bernanke, the US Chamber of Commerce, and Congress's own budget office, to name a few – also cite Congress as a factor that is inhibiting economic recovery, though they put it more diplomatically than does Mr. Obama.

Consider Mr. Bernanke's reply to lawmakers when asked June 7 about Fed efforts to stimulate the economy via low interest rates: "I'd be much more comfortable," he said, if "Congress would take some of this burden from us and address those issues."

Or take this complaint about how "uncertainty" is causing small businesses to refrain from hiring and investing. "Most of this uncertainty ... is coming out of Washington," concludes a June 14 report from the National Federation of Independent Business.

Then there's this tart assessment from the Congressional Budget Office about the consequences of lawmakers leaving unresolved some pressing decisions about future taxes and government spending. "Uncertainty about the resolution of fiscal policy early next year is weighing on the economy, we think, diminishing people's and businesses' spending this year," said CBO Director Douglas Elmendorf in June.

Wait a minute, you say? What about the debt crisis in Europe? What about the long-suffering housing market and the costs of "Obamacare"? What about layoffs in state and local governments? What about lack of presidential leadership, perhaps? Are they not to blame for the US economy running out of steam?

True, say many economists, some or all of the above contribute. But evidence is mounting that Washington's food fight last summer over raising the nation's debt limit and the "fiscal cliff" that looms at year's end are taking a toll on economic growth and employment. And both are crises manufactured in large part by an ineffective Congress.

"This economy can gain traction and really swing into full gear if we just nail down what we're going to do about the fiscal cliff and attaining fiscal sustainability," says Mark Zandi, chief economist of Moody's Analytics.

That's a big "if," if recent history is a guide.

That was then

Last summer, Congress engaged in a high-stakes game of chicken over raising the national debt limit – something it had done with few controversies some 90 times since 1940. The consensus now is that the fight hurt employment, crushed consumer confidence, caused a major credit-rating agency to downgrade the United States, and, according to a recent paper on the impacts of policy uncertainty, hampered overall economic growth for months.

The Constitution gives Congress much control over fiscal policy. It is Congress that decides government spending. Congress – not the president, not the Fed – draws up the tax code. And Congress, by its own law, controls the national debt ceiling.

The months when the debt-ceiling fight was in full swing – June, July, and August of 2011 – job creation dropped like a stone. In April of last year the US economy had generated a quarter of a million jobs, enough to keep pace with population growth. Then the debt-ceiling fight began, federal stimulus money ran out, and the Fed's quantitative easing program peaked – all affecting hiring. By June, the economy yielded just 84,000 new jobs, followed by 96,000 in July and 85,000 in August.

Consumer confidence also took a hit, falling 15.8 points as measured by the Michigan Consumer Sentiment Index. The largest drop ever – 19.5 points – came from hurricane Katrina in 2005. When Lehman Brothers collapsed in 2008, the Michigan gauge fell 15 points. After 9/11, it dropped 8.8 points.

Unlike the drops after Katrina or Lehman Brothers or 9/11, last year's plummeting confidence was Washington's responsibility.

"Never before in the history of the [monthly] surveys have so many consumers spontaneously mentioned negative aspects of the government's role in the economy, and never before have consumers rated economic policy so unfavorably," the Reuters/Michigan Survey said in releasing its August 2011 data.

Effects of the debt-ceiling fight on the economy may still be lingering. A recent paper by three economists sets out to put a price on policy uncertainty. Included in their index: the number of news media references to economic policy uncertainty, the number of US tax provisions set to expire, and forecaster disagreement over future inflation and federal government purchases.

The index spikes at predictable moments: the Gulf War, presidential elections, the 9/11 attacks. Last summer, with the debt-ceiling crisis in full swing, the index jumped to 3.5 times its average reading. The 2008 financial crisis, by comparison, caused a spike of about 2.5 times the average.

The economists calculate that greater policy uncertainty from 2006 through 2011 – of which the debt-ceiling fight was one contributor – will cost the US a 2.2 percent decline in gross domestic product (GDP), 13 percent lower private-sector investment, and 2.5 million fewer employed Americans. Those hits will manifest themselves in the economy between nine months and two years after August 2011, says the report by Scott Baker and Nicholas Bloom of Stanford University and Steve Davis of the University of Chicago.

This is now

Looming at year's end is a big fiscal crisis, a package of spending cuts and tax increases that, if permitted to occur, would probably send the US back into recession.

The crisis is in some ways a direct descendant of last summer's debt-ceiling fight: To settle it, Congress, along with Obama, mandated $1.2 trillion in draconian spending cuts over the next decade unless lawmakers devised an alternative deficit-reduction plan. They have not, and so the first $109 billion installment of cuts comes due in January.

January also marks the expiration of the Bush-era tax cuts, extended unemployment benefits, and the lower payroll tax rate, among others. Then, probably in February, it will be time for another go-round over raising the national debt limit.

Budget experts call it the fiscal cliff. Pundits give it another name: taxmaggedon. By whatever name, here's what the CBO warns will happen to the economy if the tax increases and spending cuts come to pass as currently planned: Economic growth would fall from an estimated 4.4 percent next year to 0.5 percent. Moreover, the economy would likely enter a recession in the first half of 2013 before recovering in the second half.

Congress could provide clarity, but election-year politics have gummed up an already bitterly partisan institution. The conventional wisdom is that lawmakers won't seriously engage to give businesses and consumers the certainty they are looking for on the big issues until after the November election.

Meanwhile, a brief sweep through American businesses indicates how policy uncertainty is already stymieing economic growth:

•In New Mexico, a long-delayed bill for federal highway funding put the clamps on construction. "Our [state transportation] program has collapsed," says Mike Beck, head of the Associated General Contractors of New Mexico. "We can't go out to make any long-term commitments on equipment, capital, employing people around the state without knowing what's coming down the pike in the next couple of years."

•In the defense industry, firms face layoffs because defense spending would be cut by $55 billion starting in January, under last summer's accord. A law mandating 60 days' notice for mass layoffs or plant closings means affected defense industry workers would receive notice that they might be fired on the eve of the November elections.

•In tiny Lake Jackson, Texas, Glen Hamilton, owner of a small tool-and-die business, is sitting tight until he knows what will happen with taxes, including a medical-device tax imposed to help pay for Obama's health-care reform law and a tax provision allowing 100 percent expensing of newly purchased equipment. His firm, GME Inc., has 24 employees and about $3.1 million in annual revenue.

"I'm not going to do anything until I know if they're going to let the Bush tax cuts expire," says Mr. Hamilton. "I'm not going to buy anything or hire anybody until I know that's not going to happen."

Across corporate America, as Chamber of Commerce lobbyist Bruce Josten puts it, one question reigns: "How do you plan for chaos?"

A lazy summer on the Hill?

It's not as if lawmakers on Capitol Hill are unaware of the deleterious effects – potential and ongoing – of political gridlock on the economy. Members of both parties are among those who warn of economic doom and gloom if Congress does not settle – and soon – pressing problems of debt, deficit, taxes, and growth.

What has Congress tied up in knots is the parties' strict adherence to respective political principles – and a starkly different understanding of what is causing all the uncertainty. Republicans see government overreach – whether new rules by the Environmental Protection Agency, Obama's health-care law, financial regulatory reform, or rulings by the National Labor Relations Board – as the chief culprit. Democrats say Republican intransigence is to blame for the uncertainty, pointing at actions such as the GOP's balking at raising the national debt limit and its preventing serious negotiations on a long-term fiscal solution by refusing to consider any increases in taxes alongside spending cuts.

The result is that precious little is being done to forestall potential year-end mayhem.

The House of Representatives will hold a vote on extending all of the Bush-era tax cuts before adjourning for the August recess. "We don't have to wait until the end of the year; we could extend current tax law now," says Rep. Dave Camp (R) of Michigan, chairman of the Ways and Means Committee. "And frankly, the sooner we send that signal, the better."

But that maneuver has little chance of becoming law, with Obama favoring extending those tax cuts only for couples making less than $250,000 a year.

"The root cause of the problem is that House Republicans believe that compromise is a dirty word. And that has made it virtually impossible to take a balanced approach to deficit reduction that bipartisan groups have recommended," says Rep. Chris Van Hollen of Maryland, top Democrat on the Budget Committee.

Republicans insist that their position is simply the best policy, noting recent remarks by prominent Democrats, such as former President Bill Clinton, in favor of extending all the Bush-era tax cuts.

No other votes on fiscal cliff issues are scheduled in Congress this summer.

Will the clouds ever part?

The likelihood is high that the election will come and go without one party taking control of Congress and the White House. Thus, November will resume with divided government and about six short weeks until taxmaggedon.

Lawmakers will probably come up with some short-term fixes that push the fiscal cliff deeper into the new year, risking the kind of white-hot showdown that hit the economy during the debt-ceiling confrontation. That could have disastrous consequences.

"It is all but inevitable that [the uncertainty index] will increase sharply as the debate surrounding the tax cuts heats up," wrote Kevin Hassett, an adviser to GOP presidential candidate Mitt Romney and a scholar at the American Enterprise Institute, in May. "When it does, uncertainty will likely break the all-time record set last year, which could easily take a percentage point or two off of top-line GDP growth."

Still, work is going on behind the scenes, especially in the Senate. The Finance Committee is meeting behind closed doors in an effort to devise a grand tax-reform proposal. The aim is to build trust across the aisle, and to keep election-year politics from shattering fragile discussions.

"We are all gloom and doom because there is gloom and doom in going over the cliff," says Sen. Mark Warner (D) of Virginia, one of the so-called Gang of Six senators dedicated to striking a "grand bargain" to solve America's debt and deficit problems. "But we are one budget deal away from regaining economic preeminence."

Is that view too sanguine, given that Congress seems to be lost in the woods in its search for financial direction?

Senator Warner thinks not. He is a proponent of a blueprint unveiled in late 2010 by Obama's bipartisan deficit reduction commission, known simply as Simpson-Bowles, after its authors. That plan, he asserts, would not cause immense financial pain.

The Bush-era tax cuts, for example, cost $4.5 trillion over 10 years. Simpson-Bowles would raise $2 trillion in higher taxes over that period, Warner says, leaving in place more than half of the Bush-era tax cuts. Entitlement programs get similar modifications – not insubstantial, but not gravity-altering, either.

"If this really was going to be some huge increased tax burden, if this really was going to be major surgery on Medicare or Social Security or Medicaid, then maybe it might be worthy of the battle-to-the-death mind-set of some of these folks," Warner says. "But it isn't."

Because the US can phase in its changes over the next decade, he argues, there won't need to be big immediate cuts like those seen in Greece or Britain. Moreover, Europe's precarious position is giving the US some breathing room.

"If Europe were not in the mess that they were in, we would not be seeing these massive inflows of capital driving down our interest rates," says J.D. Foster, a senior fellow at the Heritage Foundation. "So Europe, and the trouble there, has bought us time. We should not waste it."

But the longer the delay, the closer the US comes to facing deep cuts in government services and higher taxes, the hallmark of what House Budget Committee chairman Paul Ryan (R) of Wisconsin calls "bitter austerity."

But getting a deal, of course, requires Congress to move.

"I believe in miracles, but you don't want to bet on a miracle happening," says Rep. Jim Cooper (D) of Tennessee, one of the Simpson-Bowles plan's House sponsors. "That's essentially what we are doing."