Several thoughts on the adoption of the legislation:
1. A minimalist course of accommodation was undertaken. Most expiring tax provisions were renewed.
2. The AMT was "fixed" permanently without consideration of the level at which indexation would make most sense from a fiscal standpoint. A fix at some level was reasonable, but the fix at the current level means that tax revenue would be about 3.3% of GDP less than would otherwise be the case based on the CBO's 2012 Long-Term Budget Outlook (over the 2012-37 period).
3. American policy makers again punted on addressing the need for spending-related savings, particularly from mandatory spending programs (where reforms to make them fiscally sustainable remain unaddressed). These programs are the structural drivers of the nation's long-term fiscal imbalances.
In short, policy makers agreed to a solution that will increase the nation's debt by an estimated $3.9 trillion over the next 10 years (CBO Score:
http://www.cbo.gov/sites/default/files/cbofiles/attachments/American Taxpayer Relief Act.pdf). Policy makers demonstrated an ability, albeit with difficulty, to cushion taxpayers. But when it came to the structural issues behind the nation's fiscal imbalances, they demonstrated no appetite or ability to even make a downpayment in terms of reform. In short, even as the package will contribute to stronger short-term economic growth, it will also add to the nation's credit risk associated with its long-term finances.
Having said this, this deal is the best that American policy makers could achieve. It falls far short of what is needed. It is another demonstration that the concerns raised by S&P are on the mark. The American political system and/or American policy makers do not appear to be of the caliber required to address the nation's biggest challenges. In that context, especially if no deficit reduction packages are enacted in coming months, it would not surprise me if the U.S. credit rating were downgraded this year. It would also be difficult to argue against such a move.
In the wake of this deal, financial markets have rallied overseas and futures have soared in the U.S. That outcome reflects what is an Achilles Heel of sorts when it comes to markets, namely that they are an imperfect discounting mechanism on account of a pronounced bias toward the short-term (this issue really reflects the reality that humans lack prescience, hence human institutions similarly lack prescience). One saw such bias in play when the Dow peaked at just over 14,000 in October 2007, even as the housing bubble had burst during the preceding summer and the first losses were rippling through the banking system. What this means is that markets likely won't reflect the added credit risk associated with this package until interest rates have begun to rise. The timing of that outcome is uncertain, but the risk will likely increase over the medium term in the absence of a credible fiscal consolidation strategy coupled with the rise of increasingly attractive investment alternatives overseas on account of overseas economic development.
My first guess is that even as the sequester is scheduled to kick in within two months, another agreement will likely be reached on that matter to avert or postpone at least a share of those scheduled savings. The 10-year deficit reduction in that agreement probably won't greatly exceed the $3.9 trillion increase in 10-year debt tied to the fiscal cliff legislation and one cannot rule out its falling short of that figure. In short, the net fiscal changes will likely prove modest at best and they will very likely fall well short of credible fiscal consolidation.
