Nation’s reviving economy now the X factor in Washington’s fiscal fights

The long-awaited economic recovery is coming into view, potentially transforming the debate over deficits and taxes in Washington.

Stock indexes are reaching new highs, the housing market is strengthening and corporate chiefs are looking to invest — adding to a sizable pile of evidence that the economy is poised for a turnaround in the months and years ahead.

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But while major sectors and industries seem to be shaking off the rust, business executives and economists say the speed of the recovery will ultimately be determined by the fiscal battles that are playing out between Congress and the White House.  

“Everyone is feeling better, but we’re not having parties,” said John Engler, the president of the Business Roundtable, which lobbies on behalf of corporate CEOs.

The Business Roundtable and the National Association of Manufacturers — two groups with fingers on the pulse of the business world — each reported growing optimism among their members this week. 

The Roundtable on Wednesday reported an increase in CEO optimism for the first time in a year, with 38 percent of executives reporting they plan to increase capital investments over the next six months. 

The positive forecast was released the same morning that a 1.1 percent increase in retail sales was announced. That pace of growth for February — the fastest in five months — beat expectations on Wall Street and was interpreted as a sign that consumers have money to spend despite January’s increase in payroll taxes.

Still, business leaders and economists have concerns about the uncertainty on spending and tax and regulatory issues in Washington. They fear that the $85 billion in across-the-board spending cuts from sequestration that hit at the beginning of the month will weigh down growth.

“I can see real bright shining lights at the end of the tunnel,” said Ian Shepherdson, chief economist at Pantheon Macroeconomic Advisors. “Unfortunately, we’re going into the tunnel now.”

Jim McNerney, the Business Roundtable’s chairman and president and CEO of Boeing, said Wednesday that business leaders remain discouraged about what’s happening in Washington. The feeling of uncertainty in boardrooms is “very real” as lawmakers and President Obama “lurch from crisis to crisis,” he said.

Many fear the fiscal fights that will play out this spring and summer, as the two parties slug it out over taxes and spending and face the need to raise the debt ceiling again.

Senate Minority Leader Mitch McConnell (R-Ky.) suggested Tuesday that the next debt-limit hike could serve as an avenue for a major GOP push to overhaul entitlement programs, setting the stage for a repeat of the high-stakes showdown that rattled markets in 2011. 

“If the economy is able to successfully navigate through the fiscal headwinds that will be blowing hard in the next six months, then the fiscal policy debate will shift entirely to what policy would mean for the long-term fiscal and economic outlook,” said Mark Zandi, chief economist for Moody’s Analytics. 

“Unfortunately, I don’t think this will shift the politics sufficiently to achieve a substantive budget deal. I don’t think there will be any additional significant changes to fiscal policy in the foreseeable future.” 

An economic surge would be welcome news for Obama, who has seen his approval rating take a dive after warning for weeks about the impact of sequestration on the economy.

But while a growing economy might lift Obama’s popularity, it could also undermine his party’s push for more tax increases in a deficit deal. 

Republicans have stood firm against tax hikes since last year’s “fiscal cliff” deal raised some income rates, and argue the economy would flounder if Washington seizes even more revenue.

Whether the economy picks up speed this summer could depend to a large extent on the damage that is inflicted by sequestration.  

McNerney said it is difficult to quantify the sequester’s effect on the business climate because companies had been anticipating the possibility of it hitting and have moved forward with caution, especially when it comes to new hires.

The president has been accused of overstating the impact of the automatic sequester cuts, and has hinted that he expects the economy to take off despite the furloughs and cutbacks by the federal government.

“As long as the sequester is in place, we’ll know that that economic news could have been better if Congress had not failed to act,” Obama said at press conference on March 1, the day the sequester took effect.

Economists caution that while recent data has been fairly rosy, a hit on the economy because of the expiration of the payroll tax cut could still be on the way, after tax refund season passes and consumers no longer have that one-time cash infusion.

“You can’t take 1.75 percentage points out of GDP and not take a hit,” said Shepherdson. “There’s a lot of wishful thinking going on there.”

CEOs expect 2.1 percent growth for 2013, a slight increase from last quarter’s estimate of 2 percent.

And the most visible sign of economic health — the nation’s unemployment rate — is still stubbornly high, at 7.7 percent. 

Zandi has said that jobs reports through the spring and summer may be underwhelming and might not rebound until the fall. He expects the jobless rate to fall down to about 7 percent this year and, finally, below that level in early 2014.