US fiscal cliff: Will Thailand fall off too?

Now, we need to understand what the fiscal cliff is and the implication for the Thai economy in 2013. First, the fiscal cliff refers to a large predicted reduction in the budget deficit and a corresponding projected slowdown of the economy if specific laws are allowed to automatically expire or go into effect at the beginning of 2013. These laws include tax increases due to the expiration of the Tax Relief, Unemployment Insurance Re-authorisation, and Job Creation Act of 2010, and spending reductions under the Budget Control Act of 2011. 

Under current law, which mandates these tax increases and spending cuts, total federal revenues would increase 19.6 per cent from 2012 to 2013 and total federal spending would be reduced less than 1 per cent. The Congressional Budget Office (CBO) estimates revenues would rise from 15.7 per cent of GDP in 2012 to 18.4 per cent in 2013, returning to the historical average, while spending would fall from 22.9 per cent of GDP to 22.4 per cent, above the historical average of 21 per cent. The deficit for 2013 is projected to be reduced by roughly half, with the cumulative deficit over the next ten years to be lowered by as much as US$7.1 trillion. However, it is also projected to cause a double-dip recession in the first half of 2013. Now, US policy-makers are facing a Catch-22 dilemma: for the short-term impact, the deficit reduction in 2013 would adversely affect the US (and the world) economy in the short-run. On the other hand, if Congress acts to extend current policies, deficits and debt will rise rapidly over the next decade and beyond, slowing the economy over the long run and dramatically increasing interest costs.

The US CBO estimates that if the fiscal cliff scenario is allowed to take effect in 2013, it will reduce federal spending by $103 billion and increase tax revenues by $399 billion (and another $105 billion “mostly in revenue”) through September 2013 (the end of FY 2013). This would amount to a net total of $560 billion, roughly half the $1.2 trillion FY 2011 deficit. The White House estimates that a family of four with an income of $50,000 to $85,000 would pay an additional $2,200 in federal taxes. Over the medium-term, spending for federal agencies and departments, including defence, would be reduced significantly through 2022 due to the budget reduction. Within the US, the projected effects of these changes have led to calls both inside and outside of Congress to extend some or all of the tax cuts, and to replace the across-the-board reductions with more targeted cutbacks.

I think that any policy decision would come in the period after the 2012 federal elections and the end of the year. At the latest, nearly all proposals to avoid the fiscal cliff involve extending certain parts of the 2010 Tax Relief Act or changing the 2011 Budget Control Act, or both, thus making the deficit larger by reducing taxes and/or increasing spending. Thus, the likelihood of the fiscal cliff happening in the US in 2013 is rather low. However, if the unlikely were to happen, and the US economy falls into recession by -0.5 per cent in 2013, the world economy would surely be affected.  

In July, the IMF projected the world economy to grow by 4.1 per cent in 2013, with US economic growth at 2.3 per cent. Thus, if the US were to contract by -0.5 per cent in 2013, the world economy would take a direct impact of a -0.7-per cent hit, or growth of 3.4 per cent. This is a simple and direct calculation not taking into account the indirect repercussions on the major US trading partners.  

Overall, it will not bode well for the world economy and Thailand. Over the years there seems to have been a close to one-to-one correlation on Thailand’s economic growth and global economic growth. Thus, the US fiscal cliff may hit Thailand by reducing 0.5-1.0 percentage points from our baseline growth in 2013. Nonetheless, in my view the US fiscal cliff is a low probability scenario. More importantly, how the US government plans to consolidate its fiscal position over the medium-term, after the extension of fiscal cliff deadlines and the implications for the world economy, is the more important questions to ponder.

 

Chodechai Suwanaporn is executive vice president of economics and energy Policy at PTT.