The Dow Jones industrials dropped 635 points in panicked selling the first day of trading after the S&P announcement.
Outside Washington the economy has been getting some good news. Europe’s financial crisis appears to have eased, reducing the threat of a renewed financial crisis. And the U.S. real estate market finally appears to be recovering from the housing bust.
But the old worries have been replaced by new ones about political gridlock, says Joseph LaVorgna, an economist at Deutsche Bank.
The partisan divide has left businesses and consumers wondering what’s going to happen to their taxes and to federal contracts.
Companies have plenty of cash. But they reduced spending on industrial equipment, computers and software from July to September, the first quarterly drop since mid-2009 when the economy was still in recession. And hiring has been stuck at a modest level of about 150,000 new jobs per month this year.
‘‘What we see is fear,’’ says Darin Harris, chief operating for Primrose Schools, an Atlanta company with 250 franchised preschools in 17 states. He says franchise owners have been wary about investing in a second or third school until they know what tax rates are going to be and where government spending is headed. ‘‘All those things make our small business owners reluctant to reinvest.’’
Consumer confidence fell in December for the second straight month, according to a survey by the Conference Board, which blamed the drop on worries about the fiscal cliff. The uncertainty is also believed to have dinged holiday shopping, which grew at the slowest pace this year since 2008.
‘‘Every kind of brinksmanship moment is a reminder to people to not trust the economy,’’ Harris says.
Many economists are disappointed that Congress and the White House couldn’t reach agreement on a broader deal that significantly reduces the deficit over the next 10 years. That could have boosted business and consumer confidence and accelerated growth .
No progress has been made on reforming the government’s big entitlement programs, mainly Medicare and Social Security.
‘‘Nothing really has been fixed,’’ Lavorgna says. ‘‘There are much bigger philosophical issues that we aren’t even addressing yet.’’
In the early hours of the new year, the Senate passed emergency legislation to prevent deep spending cuts and even bigger tax hikes from taking effect. But the measure ran into fierce opposition Tuesday from House Republicans, leaving unclear whether a final agreement could be reached before the current Congress ends Thursday.
The Senate version would raise taxes on individual incomes over $400,000 and household incomes over $450,000 and on the portion of estates that exceeds $5 million. House Republicans are reluctant to sign on to those tax hikes — which would deliver some $600 billion in revenue over 10 years — at least without more cuts in government spending.
The higher taxes on the wealthy would likely slow the economy a little bit. But a bigger drag would come from a tax hike Democrats and Republicans aren’t even bothering to fight over: the end of a two-year Social Security tax cut. The so-called payroll tax is scheduled to bounce back up to 6.2 percent this year from 4.2 percent in 2011 and 2012, amounting to a $1,000 tax increase for someone earning $50,000 a year.
‘‘It’s a huge hit,’’ says Joel Naroff, president of Naroff Economic Advisors. ‘‘It hits people whether they’re making $10,000 or they’re making $2 million. It doesn’t matter who you are ... The lower your income, the more of your income you’re (spending). So if you’re taxes go up, it’s going to come out of your spending.’’ And that is bad news for an economy that is 70 percent consumer spending.
Mark Zandi, chief economist at Moody’s Analytics, calculates that the higher payroll tax will reduce economic growth by 0.6 percentage points in 2013. The other possible tax increases — including higher taxes on household incomes above $450,000 a year — will slice just 0.15 percentage points off annual growth, Zandi said.
The economy doesn’t have much growth to give. Mark Vitner, senior economist at Wells Fargo, predicts it will expand just 1.5 percent in 2013, down from a lackluster 2.2 percent in 2012. Unemployment stands at 7.7 percent.
A months-long political standoff over fiscal policy has already taken its toll, adding uncertainty that has discouraged consumers from spending and businesses from hiring and investing.
The squabbling seems sure to persist even if the House goes along with the Senate’s partial fix.Continued...