Economists warn of recession without US tax deal

Economists are warning US growth could stall and the United States could even tip back into recession if Congress fails to extend tax cuts and unemployment benefits before the end of the year. It seems like round 12 of the tax and spending fight between Democrats and Republicans on Capitol Hill. Yet with less than a year before voters adjudicate the winner, some are increasingly worried that spectators -- rather than one of the fighters -- is about to get knocked out. In the past week a steady stream of economists has warned that letting a payroll tax cut expire at the end of the year -- along with benefits for the long-term unemployed -- would cause US growth to slow dramatically. Unless Congress acts both measures will expire at the end of the year, withdrawing a roughly $180 billion stimulus package from the US economy. In practical terms from January 1 social security tax on employee wages would rise from 4.2 to 6.2 percent and the jobless would receive unemployment benefits for just 26 weeks rather than 99. That is very bad news for the economy according to Michala Marcussen of Societe Generale. "The baseline assumption behind our own 1.4 percent 2012 GDP growth forecast is that these measures will be extended," she recently told clients. "Should no agreement be reached, this would bring a fiscal drag of 1 to 1.5 percentage points, almost certainly tipping the US into recession." And there is good reason for believing that the measures will not be extended. The Congressional Budget Office estimates a one year extension to the tax cut alone would cost around $110 billion. In an era of rediscovered fiscal probity, neither party is willing to spend that much unless savings are made elsewhere. But in the strange world of Washington politics it is no longer Republicans who are arguing for the tax cut, and no longer Democrats who are arguing against it. Wall Street economists are looking to the failure of a bipartisan Congressional deficit cutting committee for their lead. "Given the rhetoric against deficits, any stimulus measure needs to be paid for, and the failure of the Super Committee has created doubts over where these savings will come from," said Rajiv Setia of Barclays Capital. Democrats have proposed paying for the extension by introducing a surtax on incomes over $1 million. Republicans, who have long supported tax cuts across the board, say this one does not help stimulate the economy and do not want to tax the rich. Barclays has predicted a failure to extend the measures could lead to a 1.5 percentage point drop in growth. "Were these measures not to be extended, fiscal tightening would be pulled forward to 2012," said Setia. Goldman Sachs economists have predicted a similar impact early next year. "We estimate each provision is worth roughly one-third of a percentage point," said Alec Phillips, an economist for the bank. Taking into account the knock on-effects, the impact could be "potentially up to one-half point each with multipliers," he said. Democrats have pounced on that kind of claim. President Barack Obama will visit Scranton, Pennsylvania on Wednesday to hammer the case for extensions of both measures. But some are uncertain he has the power to force the Republican hand. Speaking about the battle over temporary payroll tax cuts and extended unemployment benefits, Conrad DeQuadros and John Ryding of RDQ Economics said they expected a mixed bag. "We think the former has a much greater chance of passing Congress than the latter," they told clients. "The fate of the extended unemployment benefits, which also expire at the end of this year, is less clear because the extension of these benefits at the end of last year was tied to a two-year continuation of the Bush-era tax rates. "It is unclear what leverage the administration can use to renew extended unemployment benefits through the end of next year." Racing headlong toward elections next November both Congressional fighters may simply prefer to slug it out rather than show weakness by throwing in the towel. "Ultimately, extension will depend less on the policy itself and more on whether the two political parties can agree on whether-or how-to offset the cost of a one-year extension," said Alec Phillips, an economist for Goldman Sachs.