Will the U.S. Follow the UK Off the Fiscal Cliff?
NEW YORK (TheStreet) -- As the U.S. draws ever-closer to the fiscal geological formation that is anything but a cliff, investors seem eager to handicap what might happen should politicians fail to find a workaround.
Among the most popular theories: The UK has already fallen off the fiscal cliff, and its recent recession is a blueprint for what could happen here.
In our view, this comparison is flawed -- and though we expect moderation on some of the cliff's major components (like the 2001-2003 tax cuts), the analogy's worth exploring. It's true the UK's method of deficit reduction -- moderated spending increases combined with higher taxes -- is, at first blush, similar to the fiscal changes looming at home.
However, there are key differences between the UK and U.S.'s fiscal policies, and deficit reduction wasn't the sole driver of the UK's recession -- other causes more responsible for the UK's downturn are less likely to be issues in the U.S.Like the U.S., the UK's spending adjustments amount to more of a slope than a cliff. UK public spending has continued growing year over year, just not at the high rate initially projected. Which is similar to what the U.S. would experience under sequestration in the years beyond 2013's initial (and, rather small) $9 billion annual decline. In fact, UK government expenditure has detracted from headline GDP growth in just one of the past seven quarters. In the U.S., however, the government spending component of GDP fell from the third quarter of 2010 through the second quarter of 2012 thanks largely to state and local government spending cuts. In that regard, the U.S. has already fallen off the fiscal cliff! Yet, because the private sector remained robust, the U.S. economy continued growing. In the UK, the opposite happened -- though government spending continued growing, private-sector components of GDP contracted, tilting the economy back into recession in early 2012. This was partly due to tax increases hampering consumption and business investment, but that doesn't mean the U.S. tax increases, should they come to pass, would be necessarily recessionary. Until this past summer, the UK's top income tax rate was 50%, far higher than the 39.6% rate America's highest earners would face if the 2001-2003 tax cuts were to expire. Plus, in early 2011, the UK hiked its value-added tax (VAT) from 17.5% to 20%, eroding folks' purchasing power.
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