Fiscal Cliff ‘Meaningful Drag’ on Economy, Kashkari Says

Lawmakers and President Barack Obama probably will strike a deal in a post-election session of Congress to defer most of the $700 billion in expiring tax cuts and spending reductions known as the fiscal cliff, said Neel Kashkari, Pimco’s managing director and head of global equities.

Kashkari, speaking at the Bloomberg Markets 50 Summit in New York, said his company predicts that a deal will be reached to defer all except $250 billion of the tax cuts and spending reductions slated to start in January. Still, the U.S. economy will be hindered, he said.

“With our outlook for the U.S. economy being quite slow growth, 1.5 to 2 percent growth, a $250 billion fiscal drag is a pretty significant headwind, given our slow economic growth,” Kashkari said. “So we think we’re going to avoid recession, but it is going to be a meaningful drag on the U.S. economy.”

The deficit-reduction agreement reached last year by President Barack Obama and congressional Republicans has created a “fiscal cliff” of spending cuts and tax increases starting in January unless Congress acts to stop it. The Congressional Budget Office forecast that if Congress does nothing, the fiscal changes would trigger a recession.

‘Premeditated Crisis’

“If there is such a thing as a premeditated crisis, this is one,” Andy Stern, former president of the Service Employees International Union, said at today’s Bloomberg Markets summit. “They’ve created exactly the scenario they want to have, which is to put their backs up against the wall since that’s the only way Congress will act.”

Kashkari predicted that a deal would come together soon after the election because “Republicans and Democrats are fighting a lot and making a lot of noise, but they agree about a lot more than they disagree.” Both parties, for example, probably will agree to let a payroll tax cut and expanded unemployment benefits end, he said.

Obama has been silent on whether to allow the 2 percentage- point payroll tax cut that he championed in 2011 to expire at the end of the year. He has focused instead on extending the George W. Bush-era tax cuts on income up to $200,000 a year for individuals and $250,000 a year for married couples, while letting them expire for top earners.

Republicans, who control the House, are insisting on extending the Bush tax cuts, which expire Dec. 31, for all income levels.

If Obama wins a second term and Republicans gain majority control of the Senate, Obama would probably press for the best deal he could get during the post-election session, Stern said. Should Republican presidential candidate Mitt Romney win on Nov. 6, there will be “a lot of willingness to give him time to look at the situation, make his own plans,” Stern said, predicting that a deal would come later.

’Real Damage’

Lawmakers “did real damage to the U.S. economy because of their fighting right up until the last minute” in 2011 over whether to raise the federal debt ceiling, Kashkari said, adding that Pimco was having trouble quantifying how injurious down-to- the-wire negotiations at the end of 2012 might be.

“The big uncertainty is how much brinkmanship there is during the lame-duck session, how much it hurts confidence, just like we saw a year ago with the debt ceiling fiasco,” he said.

To contact the reporter on this story: Kathleen Hunter in Washington at khunter9@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net

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