One of the few certainties in the markets is that markets hate uncertainty. After the US election, some things are clear – gridlock means no partisan legislation will be passed, for example – but the most important domestic political risk facing investors remains as uncertain as ever.
This, the expiry of the Bush tax cuts in January, equates to a tax rise of $138bn next year, and more than $200bn in 2012 – a negative stimulus when the economy is already struggling. Moody’s Analytics suggests it would be enough to tip the country back into recession.
The effects of the tax are startling. The independent Congressional Budget Office estimates that gross national product will be 0.5-1.4 per cent higher in real terms next year if the tax cuts are extended.
How will the election affect the tax cut debate? Back in 1994, the last time a Democrat president lost the midterms, Bill Clinton responded by moving to the centre, dropping healthcare reform and painting the Republicans as extremists.
If Mr Obama responds as Mr Clinton did, that would ease the way to compromise on tax cuts. The White House wants to extend them permanently for everyone except the rich, which CBO projections suggest would create 1.3m to 3.5m full-time jobs.
The Tea Partiers insist on full extension of the tax cuts for everybody. A full extension would create more jobs, but the biggest beneficiaries would be the very richest. Both plans would worsen the out-of-control federal deficit, by up to $3,300bn over 10 years. The best outcome economically, and a potential compromise, would be to extend most of the cuts for a year or two, until the deficit can be tackled properly.
There are reasons to be hopeful. The failure of high-profile Tea Party candidates might reduce its influence with Republicans somewhat, and make compromise more likely. But partisanship in Washington remains one of the few things we can be sure of in this uncertain world.
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