IE 11 is not supported. For an optimal experience visit our site on another browser.

Uncertainty over budget cuts weighs on growth

This week's naming of 12 congressional appointees to a bipartisan budget-balancing "supercommittee" has ended jockeying and speculation over who would be on the critical panel.

But the news did little to lift a cloud of uncertainty that has cost the United States its unblemished credit rating, damaged business and consumer confidence and sent the stock market on a wild ride, eliminating trillions of dollars of shareholder value in just a few weeks.

Established following the failure to reach agreement on a "grand bargain" of spending cuts and tax reform, the supercommittee faces a Nov. 23 deadline to find ways to reduce the federal budget deficit by $1.5 trillion over 10 years. Congress has until Dec. 23 to approve or reject the package.

If the panel fails to find common ground, or Congress rejects the proposal, some $1.2 trillion in "automatic" cuts will fall equally on defense spending and other government programs, with a potentially damaging economic impact.

With the acrimonious partisan debate still fresh on their minds, the panel has its work cut out for it.

"You wouldn't want to be in there while the 'Dirty Dozen' are up to their work, because, boy, I tell you, the hair and eyeballs will fly all over the floor," said former Sen. Alan Simpson, R-Wyo., who co-chaired a bipartisan deficit commission that issued nonbinding recommendations for  trillions in savings last year.

The hope is that recent signs of a weakening economy, the stock market sell-off and the loss of AAA credit status will provide a new sense of urgency to the committee's work. But some business executives remain skeptical that Congress and the White House will be able to fashion a package that gets the economy moving again.

"The uncertainty is not the problem, it's the certainty that's the problem," said Harvey Golub, former American Express CEO and former AIG Chairman. "We know that until the next presidential election in this country we're going to pursue policies that will be different from the rhetoric. We will say what we want to do is grow GDP and create jobs, but the policies that will be put in place will do the opposite."

With consumer spending stalled and industrial production weakening, government spending remains an important component of gross domestic product. The fear is that, with state and local governments already slashing spending, deep cuts in the federal budget will slow growth further. At $1.4 trillion, the federal deficit represents about 10 percent of GDP.

The federal government has been spending heavily, especially since the financial meltdown of 2008, to keep the banking system and broader economy afloat and to kick-start the economy. But the backlash against deep deficit spending means that fiscal policy is beginning to act as a headwind to growth instead.

Similarly the Federal Reserve has virtually run out of tools for stimulating growth and this week a deeply divided central bank panel took the unprecedented step of saying it would hold interest rates at current, exceptionally low levels, at last until mid-2013.

The tacit acknowledgement that growth is expected to be extremely slow for two more years helped contribute to a stock market selloff that has now destroyed some $2.8 trillion in wealth, more than all of the cash provided by the Fed in various cash-injection programs over the past three years.

Tax reform remains a potential tool to boost growth, according to some analysts. But tax reform was the issue that sank a proposed "grand bargain" in the final hours before a more limited deal was struck to allow the Treasury to continue to pay its bills. The deal would have cut the defect by $4 trillion, but House Republicans and the White House deadlocked over proposed increases in revenues.

"When you're in a fiscal contraction as we are now to some degree, what we need to do is really focus on growth," said P. Eugene Ludwig, Promontory Financial Group founder and CEO and a former comptroller of the currency in the Clinton administration "To some degree, that means lower taxes. What we need to do is reduce or eliminate the payroll tax, because ordinary citizens are paying a regressive tax there. And we also ought to be lowering taxes on business. We've got to get the economy started again."

In their public comments, panel members have insisted that they are open to new ideas. But all six Republicans have opposed tax increases, some more than others.

"We can't have great confidence that we're going to get a 'grand bargain,' but the option is there and I think the opportunity is there," said Norm Ornstein, a fellow at the conservative think tank American Enterprise Institute.

The panel is expected to begin preliminary meetings via teleconference during the August recess, and begin work in earnest in September. But it's widely expected that the details of the plan won't be finalized until the eleventh hour of the Thanksgiving deadline. That means that —regardless of the final outcome — business, consumers and investors will have to wait and see whether and how deeply the budget axe falls.

That uncertainty — more than the cuts themselves — could weigh most heavily on growth. The longer government policies continue to shift, the longer it will take to get the economy moving again, according to Wells Fargo chief economist John Silvia.

"You have a payroll tax cut and then you don't. You don't know if you are going to have the Bush tax cuts or not. You have Cash For Clunkers and then you don't. You can't do that," he said. "You are asking people to make permanent decisions in terms of hiring and spending money, and then you give all these temporary policy moves. It doesn't work that way."