US election noise obscures approaching fiscal precipice The path to economic recovery runs along the edge of a fiscal cliff and few countries seem able to walk it without falling off. Last week the UK, a pin-up of pre-emptive austerity, returned to recession; unemployment in Spain neared one in four as it battled to avert a debt crisis; and government cutbacks contributed to sluggish US growth for the sixth quarter in a row. There is no doubt that government finances must be restored to balance in the medium term, but attempts to do so quickly are foundering, because private demand is proving slow to recover in the wake of the financial crisis and its recession. More by paralysis than by judgment, the US has adopted a gentle path of fiscal retrenchment so far, with the expiry of stimulus measures rather than active cuts to the short-term deficit. But all that could change at the end of this year. Even as advisers to the Romney and Obama campaigns commence open warfare over their long-term approach to tax and spending, policy makers are fretting about the enormous fiscal cliff - in the US it is more of a fiscal precipice - that they will have to navigate as soon as the election is over. As 2012 turns into 2013, by political design, the income tax cuts passed by former president George W. Bush will expire, a temporary payroll tax cut will end, and spending cuts worth $1,200bn over ten years will come into effect. This amounts to an overnight fiscal tightening of about 4 per cent of gross domestic product. It means an automatic recession unless Congress acts to stop it. "I think it's important to say that if no action were to be taken by the fiscal authorities, the size of the fiscal cliff is such that there is, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy," said Ben Bernanke, the Fed chairman, last week. No one expects the US to jump headfirst off the fiscal cliff, of course, and handicapping the post-election fiscal negotiation is a popular parlour game in Washington. A fairly conventional view is that the spending cuts - which were designed to be universally unpopular - will not happen; the payroll tax cut will expire; and the extent of any income tax rises will vary with the outcome of the election. The big danger, though, is that the size of the fiscal cliff and the equally high political stakes mean a bias towards more tightening than is healthy for the economy. This is true regardless of the election results: even if Barack Obama is re-elected as president, Republicans are likely to control the House of Representatives; even if the GOP sweeps all three arms of government, there will still be enough Democrats to filibuster in the Senate. The perceived winner of the election will have moral authority to impose their vision on fiscal policy, but for Democrats to allow permanent extension of the Bush tax cuts would be a concession of utter defeat, while Republicans in control of any chamber of Congress will surely demand spending cuts as part of any package that raises revenues. Congressional negotiators are famously ingenious and it is possible to imagine all manner of baroque compromises that limit the actual fiscal contraction going into 2013. For example, they could agree to keep tax rates as they are for a year, while carrying out a broad tax reform that raises extra cash in future years. But it is hard to imagine any deal that does not involve a minimum fiscal tightening of 1 per cent of GDP and most likely more. Europe's woes, as well as a recent run of weaker labour market data in the US, raise questions about the economy's capacity to absorb even that. The fiscal cliff is still on the horizon and all the noise of the election will obscure the fact that it is drawing closer. But that creates another risk for the economy: of a collective panic attack when the nation wakes up on November 7, having chosen a new president, and realises how narrow the path is around this vertiginous drop.