December 28, 2012

State of Alabama
Press Release: Alabama Department of Commerce

Consumers, Businesses Brace for 'Fiscal Cliff' Impact

December 27, 2012

For much of this year, business managers have blamed uncertainties over the looming “fiscal cliff” for their reluctance to pick up the pace of new hiring.  

As the budget deadline nears with no deal in sight, we may be about to find out just justified those fears are.

Without a deal, the current budget law calls for a half-trillion-dollar package of tax hikes and spending cuts that most forecasters warn would, if left in force for long, send the U.S. economy back into recession.

After strong gains in income in November, American households will see their paychecks shrink a bit when a two-year payroll tax "holiday" expires Dec. 31. The new rate will clip 2 percent from every dollar of wage income, or about $20 a week for someone making the median salary of $50,000 a year.  

“People will start to feel it fairly quickly in their paychecks,” said Ian Shepherdson, an economist at Pantheon Macroeconomic Advisers. ”I don't think the economy will fall apart completely (in the short term). But we’ve seen already that business confidence is weakening and consumer confidence is weakening. So the uncertainty is a problem.”

Small business owners are especially negative. Just five percent of them plan on adding new jobs, according to the latest monthly survey of its members by the National Federation of Independent Businesses. Only 19 percent said they plan to invest in new equipment in the next three to six months.

The business gloom does not bode well for the U.S. economy, which already faces weak conditions on several other fronts. Export growth is slowing as a European recession and a slowdown in China weigh on global demand for American products and services. Growth in government spending likely will slow – whether or not a budget deal is reached to avoid the deeper cuts already set to kick in. That leaves spending by business and consumers to keep the economy afloat.

It remains to be seen whether businesses are holding back because of the ongoing budget battle. An alternative explanation is that business owners are hoping their can maximize profits by spending less and hiring fewer full-time workers, instead making do with temporary or part-time workers more or less indefinitely.

“That means more temporary workers, less investment in the future, lower productivity gains and a lower growth rate in the future,” said UBS economist Drew Matus. “That’s a worst case scenario. So we all better hopes it’s the fiscal cliff causing some of these people to hold back.”

Though hiring picked up in the second half of this year, the overall pace is far lower than typically seen more than three years into an economic recovery. Since the 2007 recession ended, the number of part-time workers who can’t get full-time work has been stuck at double the level seen when the downturn began.  

The spectacle of political dysfunction is likely to keep business managers in a sour mood for some time. 

Though the new package of tax hikes and federal spending cuts is set to begin Jan. 1, the impact of those new measures will be felt gradually. Tax hikes will be spread over a full year. Some government agencies may postpone spending cuts in hopes that they'll be reversed before the fiscal year ends Sept. 30.  

More worrisome is the pending fight over raising the debt ceiling, which will exhaust the government’s borrowing authority in February.

Unless lawmakers agree to extend it, the Treasury faces the same threat of default that threw the budget process into chaos in July 2011 and cost the U.S. its Triple-A credit rating. The three major bond rating agencies have already warned that failure to reach a credible deal to contain federal budgets deficits could bring yet another downgrade.

The best case scenario has Congress returning in January to enact a compromise agreement that President Barack Obama signs into law, lifting the pall over business and consumers and sparking a fresh spurt of economic growth.

“That’s sort of what happened last summer when we had the debt ceiling fiasco,” said Sheperdson. “Things rebounded fairly quickly. But while the negotiations were going on, payroll growth rolled over. And I’m nervous that we could get something similar this time.”

Until the budget fiasco is resolved, with businesses sitting on their hands, consumers remain the last best hope to keep the economy afloat.  

“The consumer has really been holding things up,” said Joel Naroff, chief economist at Naroff Economic Advisors. “Whether its retail sales, whether it's motor vehicle sales and even the biggest sales of all, housing, the consumer has been out there.”

Though wages have remained nearly flat since the recession ended, U.S. households have continued to pay down debt. Record lower interest rates have sparked a wave of refinanced mortgages that have plowed billions of dollars back into household budgets.

But the protracted display of Congressional incompetence may already be weighing on consumer spending, which accounts for 70 cents of every dollar of gross domestic product.  On Friday, the latest read on consumer confidence, from a monthly Thompson Reuters/University of Michigan survey, showed that consumer sentiment fell sharply in December.  A private survey, released Monday, similarly showed confidence getting eroded by fiscal cliff worries.

Without a budget deal, higher taxes will crimp consumers’ spending power – but only gradually. That’s why many economists believe the fiscal cliff is really more a like a slope.

Naroff likens the budget deadline to a snowball that will be released Jan. 1, picking up size and force as it continues to roll down the hill.

“To me the biggest uncertainty in all of this – and for which we don’t have any estimates - is what happens to confidence?” he said. “If consumers say, ‘Hey, this thing is really getting very bad, Congress doesn't know what it is doing.  I'm cutting back.’ then we could have the snowball hit on consumer spending - with weakness in the business side. And then you have a real problem.”

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