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Will the U.S. Follow the UK Off the Fiscal Cliff?

Even among the U.S. tax increases that likely won't be compromised away, such as the expiration of the payroll tax holiday and the new taxes on investment income under the Affordable Care Act, none should have the sweeping (and regressive) impact of the UK's VAT hike. Higher dividend taxes may seem problematic on the surface, but remember, firms have other means of returning profits to shareholders.

Perhaps the most important difference between the UK and U.S. is each country's regulatory environment and the impact on lending. In the UK, falling lending likely bears much blame for the private sector's struggles. Banks are lending only to the most creditworthy borrowers, largely shutting out many small businesses and entrepreneurs, making it extraordinarily difficult for most firms to invest and expand.

Banks' hesitance to lend is largely due to regulatory uncertainty. Since the government telegraphed regulatory changes in 2009, banks have anticipated having to adjust business models and increase capital buffers, but they're still waiting for clarity on the actual rules.

The government released its regulatory overhaul proposal in June 2012, but the measures still remain subject to parliamentary debate. Behind the scenes regulators are lobbying for even stricter oversight than the government proposed, including the ability to arbitrarily set banks' leverage ratios and mandate they build up countercyclical capital buffers. Faced with these possibilities, banks have incentive to hoard capital and limit balance sheet risk, not lend.

While the U.S.'s regulatory landscape isn't great, the U.S. is about two years further along in the process than the UK. The major financial legislation was passed in 2010, the rules have slowly taken shape, and banks have some clarity -- hence, U.S. loan growth, though not stellar, is picking up.

That lending is improving despite Federal Reserve programs like Operation Twist, which flattened the yield curve and narrowed banks' profit margins (and, by extension, their incentive to lend), speaks volumes about the relative health of U.S. banks and their ability to continue funding corporate America.

As long as U.S. firms can continue securing funding, whether through banks or primary debt markets (where yields are at historic lows), there's plenty of fodder for future expansion and growth.
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