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Gaming US Fiscal Reform

NEWPORT BEACH – It sounded like a really clever idea: Use a very public and sizeable threat to get bickering politicians to collaborate and compromise. Well, it has not worked so far, and the already-sizeable stakes just got bigger.

No, I am not talking here about Europe’s debt crisis, decisive resolution of which still requires greater cooperation and shared responsibility, both within individual eurozone member states and between creditor and debtor countries. I am referring to the complex fiscal situation in the United States – a fluid problem that has just been rendered more consequential by the recent warning from the ratings agency Moody’s that the US could lose its top credit rating next year if Congress fails to make progress on medium-term fiscal reforms.

Hobbled by the self-inflicted wounds of the debt-ceiling debacle in the summer of 2011 – which undermined economic growth and job creation, and further damaged Americans’ confidence in their political system – the US Congress and President Barack Obama’s administration recognized the need for a measured and rational approach to fiscal reform. To increase the likelihood of this, they agreed on immediate spending cuts and tax increases that would automatically kick in (the “fiscal cliff”) if agreement on a comprehensive set of fiscal reforms eluded them.

On paper, at least, this sizeable threat – involving blunt fiscal contraction amounting to some 4% of GDP – should have properly aligned incentives in Washington, DC. After all, no politician would wish to go down in history as being responsible for pushing the country back into recession at a time when unemployment is already too high, income and wealth inequalities are increasing, and a record number of Americans live in relative poverty.