Fiscal flailing, continued | FT Alphaville

Fiscal flailing, continued

Goldman Sachs has updated this chart, which shows the projected impact of fiscal policy on GDP growth, to reflect its latest assumptions (see the previous version here):

The dotted line that dips through 2012 is what would happen if, um, nothing happens — that is, no new fiscal measures are passed in 2012. The bars and the black line are Goldman’s forecast.

Goldman’s assumptions include the payroll tax cut’s extension through the end of the year. Emergency unemployment benefits will also probably be extended, but the analysts expect that the maximum duration will be reduced from 99 weeks to 79 weeks.

The obvious barrier is that Congress will have trouble agreeing on offsetting spending cuts. The two-month extension through the end of February is being paid for primarily through higher fees on mortgages sold to the GSEs. Finding offsets for the remainder of the year — another $170bn would be needed — will be more difficult.

And as Goldman reminds us, emphasis ours…

This will mark the fourth attempt in the last year to reach agreement on a package of specific spending cuts–the first was in the debt limit deliberations, where negotiators instead opted for broad spending caps; the second the super-committee deliberations in November, and the third the payroll tax cut negotiations in December–so it will clearly be a challenge to come up with the $170bn or so needed to cover the cost of extending these provisions for the remainder of the year.

In theory, if an agreement on spending cuts and/or revenue increases is not reached, it could threaten extension of these measures. However, it is also possible that in that event Congress would simply resort to using accounting strategies, such as counting paper savings from the likely drawdown of troops overseas over the next several years.

(At this point it’s not considered politically feasible to simply ignore the offsets, finance the extensions through the deficit and leave medium-term deficit reduction to a more comprehensive legislative act later. But for what it’s worth, that would be FT Alphaville’s preference.)

Anyways, you can expect the deliberations to be dragged out until the end of February.

The extension of emergency unemployment benefits is the much smaller issue in macroeconomic terms — we don’t mean to ignore the human side of this — but is more complicated, and Goldman provides a handy explainer:

The current unemployment benefit structure consists of three pieces: (1) regular state benefits (up to 26 weeks), (2) federal “emergency unemployment compensation” (EUC), which provides up to 53 additional weeks of benefits, and federal “extended benefits” (EB) which provides up to 20 more weeks, for a total of up to 99 weeks. The Senate is likely to push to maintain the full 99 weeks, as it did in December in the two-month extension. The legislation that the House passed in December 2011, but which failed to become law, would eliminate two of the EUC tiers, shortening the maximum benefit duration to 79 weeks.

In addition to the “hard” cap on benefits of 99 weeks under current policy (79 weeks under the House proposal), benefits also fluctuate based on the unemployment rate within each state. The main issue is that the formula for EB eligibility depends not only on the level of unemployment within a state but also the increase in that level over the last few years. In order to maintain broad eligibility, Congress at the end of 2010 extended the normal two year “lookback” period to three years, in order to allow more states to demonstrate the minimum increase in the unemployment rate necessary to qualify. The most recent two-month extension does not extend this further, and it seems unlikely that a full-year extension will do this either. Thus, over the first half of 2012, it is likely that eligibility for EB will phase out in many states, reducing benefits by another 20 weeks.

The upshot is that unemployment benefits are likely to be renewed, but probably at a reduced level from current policy. The Congressional Budget Office (CBO) estimates that the House bill would result in benefit payments of roughly $35bn through early 2013, or roughly $15bn less at an annual rate than extending current policy. This reduction in fiscal transfers would most likely be concentrated in Q2 2012.

Incorporating this into our fiscal policy assumptions produces the path for the overall effect on growth of fiscal policy (including state/local government) shown below (also shown is the effect of current law through 2012, which reflects the scheduled expiration of the payroll tax cut and emergency unemployment benefits–EUC and EB–at the end of February).

It’s been obvious for some time that there’s likely to be a fiscal drag on growth this year. State and local governments could well outperform expectations here, but almost certainly not by enough to bring the government’s contribution to growth back to neutral.

And as we explained in a prior post, this doesn’t even get into the various fiscal policy issues that the federal government might have to contend with after the presidential election and before the end of 2012: renewed debate over the sequestration cuts from the Supercommittee impasse, the expiration of the Bush tax cuts, the debt ceiling (yep), and if the economy is worse than expected, looking anew at again extending the payroll tax cut and emergency unemployment benefits.

Gonna be another busy year, as if you needed to be reminded.

Related links:
Fiscal flailing – FT Alphaville
What awaits you, Mr President(-elect?) – FT Alphaville