Wall Street on Wednesday celebrated Congress‘ vote to prevent sharp tax increases from hitting the economy and causing a recession this year, with the Dow Jones industrial average surging by 308 points. But economic gurus warned that the deal falls short of solving the nation’s huge debt problems.
The House late Tuesday night gave final approval to a bipartisan compromise that raises taxes by $650 billion over the next 10 years primarily by allowing tax rates on the wealthy to revert to 1990s levels. Economists said the measure likely will slow economic growth this year but not plunge the economy into a recession, avoiding the dire outcome of originally scheduled tax increases.
“We have managed to avert some of the ‘fiscal cliff.’ It’s time to celebrate,” said Leon LaBrecque, chief strategist at LJPR, an investment management company, expressing the relief of many on Wall Street who had been dreading the arrival of the Jan. 1 deadline for months.
“The deal is done” after a half-year of uncertainty that plagued the markets and hung over the economy in 2012, said Gary Thayer, chief macro-strategist at Wells Fargo Advisors. “This compromise will not solve the longer-term debt and deficit problems facing the United States” because it does not include major spending cuts or entitlement reforms, he said. “But it will prevent major tax increases on most Americans, and will, therefore, likely keep the economy from falling into recession.”
By putting off for two months across-the-board cuts in discretionary spending that had been scheduled to go into effect Tuesday, the deal forged by Vice President Joseph R. Biden and Senate Minority Leader Mitch McConnell, Kentucky Republican, sets up a new deadline of March 1 for negotiating spending cuts and entitlement reforms needed to control the deficit over the long term. The nation’s $16 trillion debt limit also will have to be raised in that time, providing further pressure for a deal and another vehicle for enacting budget reforms.
“The impact of all of this should be to slow the U.S. economy in the first half of 2013, but not put it into recession,” said David Kelly, chief global strategist at J.P. Morgan Funds.
While a fight still looms over spending reforms and carries uncertainties for businesses and the economy, Mr. Kelly said the biggest impact on the economy this year most likely will come from the Jan. 1 expiration of President Obama’s 2 percentage point payroll-tax cut, raising taxes by an estimated $100 billion on taxpayers at all income levels.
“That is where the impact is likely to be greatest — consumer spending on basic goods and services like groceries, clothing, restaurant meals and gasoline should all take a hit over the next few months due to lower take-home pay,” he said.
But for the time being, investors were relieved that Congress acted to avoid the very worst. In the most powerful rally on Wall Street in more than a year, the Dow ended up 308 points at 13,413, a gain of more than 2 percent that brought it within reach of a five-year high. The Standard & Poor’s 500 index and other major stock indexes also rose more than 2 percent, as did major indexes in Europe and Asia overnight.
Mark Zandi, chief economist at Moody’s, said the deal prevents major damage at a time when economic growth was otherwise poised to accelerate from last year’s 2 percent rate. He estimates that the tax increases taking effect this week will keep growth at about 2 percent this year and lead to the creation of 600,000 fewer jobs.
But Mr. Zandi was concerned about a further potential dampening effect on economic growth as Congress and the White House continue to wrangle over spending and the debt limit ahead of the March 1 deadline.
“This means more political brinkmanship this year, with uncertain consequences for business, consumer and investor confidence,” he said. The stock market and consumer and business confidence already took major plunges in December because of the political fight over the fiscal cliff.
Mr. Zandi was one of many analysts who pointed out that while Congress prevented the worst from happening Tuesday, it did not resolve the government’s overarching debt and deficit problems that threaten the economy over the long term.
“Perhaps the deal’s biggest shortcoming was its failure to bring the federal government closer to fiscal sustainability,” Mr. Zandi said. “My guess is that this current round of bargaining will reduce the federal deficit by $1.6 trillion over 10 years — about half as much as needed to stabilize the nation’s debt-to-GDP ratio later in this decade.”
The International Monetary Fund made the same point Wednesday, saying the measure did not go far enough to prevent an eventual sovereign debt crisis like the one in Europe.