Political Gridlock and Fiscal 2012

Brittney Barrett  |

The obstacles facing the economy in the coming year mount by the day and while the American media tends to elevate the European debt crisis over American inaction, both may have an equal impact in the coming year.

An inability by the super-committee to come to an agreement on three major issues: unemployment benefits extension, medicare and the payroll tax are threatening to hamper economic growth. The three are inexorably tied within the debt deal and the failure to agree on cuts had put them in danger of expiration. The gridlock, in and of itself, has an impact on stocks. Each time the committee misses a deadline U.S. stocks tank, but, if the inaction continues, the effect it will have is more far-reaching than a one day decline.

The payroll tax cut and the extension of unemployment benefits are both set to expire at the end of this year and according to Nouriel Roubini, the Chairman of Roubini Global Economics, this would cause a “fiscal drag of $350 billion,” or 2.3 percent of the GDP in 2012. Even if a conclusion was reached on the deal, Roubini says the fiscal drag would be equal to $200 billion or 1.3 percent of the GDP. Considering the economy expanded at a rate of 2.0 percent last quarter and is anticipated to reach 3.0 percent this quarter, a drag of this size would be the difference between minimal growth and a growth rate of essentially zero. Not only would a growth rate of this level weigh on jobs and further hamper the recovery, it would threaten to crush equities as the notion of a double dip would evaporate investor confidence in the possibility of a recovery.

To delve into what the situation is exactly, the payroll tax refers to the amount paid toward Social Security. Last year, amid a plodding recovery, President Obama consented to an extention of a reduction in the payroll tax, to maintain it at 4.2 percent rather than the 6.2 percent traditionally applied. If the payroll tax extension is not agreed upon, that would be an additional $180 billion being paid out in taxes, according to Yahoo. That $180 billion could otherwise be used on consumer spending which would help improve the rate of economic growth as well as consumers' attitudes regarding the state of the economy and their investments in the market.

The extension of the unemployment benefits has a similar impact. Almost all money paid out through unemployment benefits goes back into the economy, as the checks are often spent quickly on necessities. Should those people suddenly have no money and continue to have no jobs, that spending would stop and eat away at the economic growth rate. There's a natural argument for those who strongly believe that paying out benefits adds to the government's high debt. However, economists expect an abrupt end to some of these support programs to reflect negatively on the economic growth rate as people depending on their benefits would not have the means to make purchases.

To put in the words of Gary Burtless, a senior fellow in economic studies at Brookings Institution who spoke to Yahoo,"It increases the headwinds for this economic expansion… It makes it much much harder for a weak economy to expand at all."

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