President Obama signed the American Taxpayer Relief Act of 2012 into law on January 2. While the passage of the act did reduce uncertainty about the tax burden facing U.S. households this year, it did not address all aspects of the Fiscal Cliff. There are three key pieces of the puzzle left to be put into place. The first will be the raising of the debt ceiling. The U.S. debt technically exceeded the statutory debt limit on December 31, 2012. The U.S. Treasury is now using “extraordinary measures” to keep the federal government solvent. The effectiveness of these measures will be exhausted by mid-February according to the Congressional Budget Office (CBO). The second piece is the budget sequester. Congress simply kicked that can down the road, and not very far. The $110 billion worth of automatic spending cuts are now set to engage on March 1 unless another deal is struck. The sequester still represents a potential drag of 0.5 to 1.0 percent on GDP growth, in addition to the drag from now higher taxes. The third and biggest piece of the fiscal puzzle is entitlement spending. The long-term budget projections of the CBO show a ballooning federal deficit if growth in entitlement spending is not reduced. The near-term issues posed by the sequester will quickly be eclipsed if nothing is done about the two-thirds of the Federal budget spent on Social Security, Medicaid and Medicare, still deemed non-discretionary. The coincidence of the debt ceiling debate with the sequester and the issues regarding entitlement spending suggest that the gloves are still off in Washington, and much bare-knuckle politics is left to happen over the next two-and-a-half months.
Taxes have gone up for most U.S. households. The temporary payroll tax cut put in place in January 2011 has expired, increasing social security taxes for the average worker by about $700 per year. Also, income tax rates, dividend taxes and capital gains taxes for the wealthiest one percent of Americans, single-filers earning more than $400,000 per year, have gone up. All told, the additional tax bite is estimated to increase federal revenue and decrease after-tax personal income by about $160 billion this year. The drag to real disposable income (after inflation and taxes) will be seen in the first quarter of this year. We assume that consumer spending will feel the drag from increased taxes, as consumers tighten their belts, but that will not be enough to drive the U.S. economy back into recession. See more discussion on page 2.
Payroll job growth in December met consensus expectations, up 155,000 for the month. The unemployment rate for November was revised up from 7.7 to 7.8 percent, and was unchanged at 7.8 percent in December (that is also where it was last September, so no improvement over the last four months of 2012). Hourly earnings were up 0.3 percent for the month. Both the overall jobs numbers and the earnings numbers were helped by gains in manufacturing employment, up 25,000 for the month, and by construction employment, up 30,000 for the month. Given the concern about fiscal policy and the half-baked resolution of the Fiscal Cliff to date, the December jobs numbers provide some reassurance that the economy did not completely fall out of bed at the end of 2012.
Click here for the complete January 2013 Comerica U.S. Monthly Economic Update: USEconomicUpdate0113.