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Doom and Gloom?

12:00 AM, Nov 17, 2012 • By IRWIN M. STELZER
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Three sorts of players will determine the near-term future of the American economy: consumers, businessmen, and politicians. Only one seems to be willing to give the economy a boost—consumers. At least, that has been the case until now as consumers flock to auto showrooms to replace aging vehicles, and re-enter the housing market, driving sales and prices up. Indeed, builders who were moaning about the lack of buyers now complain that they cannot find enough skilled construction workers. Never mind that unemployment remains high and income growth low-to-negative; consumers have been sufficiently confident—the highest level in five years—to dip into savings to gratify their current wants.

US Capitol Building at night Jan 2006

Unfortunately, that recent past is not necessarily prologue. Spending fell last month. Looking ahead, we don’t know how superstorm Sandy will affect consumer spending in the final quarter of the year. This week’s spurt in claims for unemployment insurance suggests that many workers could not get to their jobs, and that many businesses are having difficulty resuming operations. No pay check, no spending. Unless, of course, the need to rebuild and re-fit houses and businesses leads to the spurt in sales that chains like Home Depot are anticipating. In short, we just don’t know the near-term effects of Sandy. In the longer run, the storm will matter less: if we could durably spur sales by destroying homes and businesses, there would never be a construction slump, and floods, Fukushima, and hurricanes would be positive economic events.

Consumer spending might also falter in the face of that old bugaboo “uncertainty.” No one knows whether the President and Republicans who control the House of Representatives will come to some agreement to avoid the fiscal cliff, Friday’s optimistic turn by congressional leaders before the television cameras notwithstanding. If they don’t, taxes will go up and spending down, yanking about 4 percent out of GDP. Economists say we will dip into recession—shallow or sharp, short or long, depending on the crystal ball being consulted.

Only by diving over the cliff would we find out. A few things, however, are clear right now. The president is in no mood to compromise. He is calling for tax increases twice as large as those he demanded before the election. These are incorporated in his last budget, rejected by the Democratic controlled senate 99-0. Beneath promises of openness to new ideas lurks the old “I won” attitude, an unwillingness to discuss at this stage any reductions in entitlements—Medicare, social security (pensions)—or in spending on infrastructure, green energy, education, research and development. First, says the president, tax rates—and other taxes—must go up on everyone earning more than $200,000. Then “we can shape a process whereby we look at tax reform” and, presumably, the entitlement cuts that his trade union allies have told him they find unacceptable. To accept higher taxes now and gamble that Obama will cut spending later would be “a sucker bet” according to Wilbur Ross, an investor on everyone’s “rich list.”

Republicans are under increasing pressure to make some sort of deal since the president holds all the cards, and increasingly prepared to cave in, as comments by several Republican governors, assembled a few days ago in Las Vegas, make clear. Even in the increasingly unlikely event that a majority of Republicans hang tough, Obama can let us drop over the edge, let taxes rise on all income groups, and immediately push through a tax cut for middle-income taxpayers that gives him what he is demanding—higher rates on those earning over $200,000, restoring existing rates for others.

In any event, deal or not, higher earners will see their taxes rise, both because of Obama’s higher rates and because Republicans have already agreed to cut provisions from which they benefit—deduction of charitable contributions, interest paid on mortgages on second homes, lower rates on dividends and capital gains. Bad news for charities, housing, and high-end retailers.

If middle-income consumers believe that the President will protect them from tax hikes and from lay-offs due to cuts in defense and other spending, they will storm the malls in search of bargains. Because many stores will open on Thursday evening rather than the usual early Friday morning, the mall crush will occur immediately after we carve up some 50 million turkeys on Thanksgiving afternoon.

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