Companies are starting to delay hiring and spending out ofconcern that Congress won't reach a compromise in time to avoidautomatic tax increases and budget cuts that would pull billions ofdollars of purchasing power out of the economy.

Faced with a so-called fiscal cliff of more than $600 billion inhigher taxes and reductions in defense and other governmentprograms in 2013, U.S. companies are pulling back, though thedeadline for congressional action is more than six months away.

The best strategy for companies to follow when confronted withsuch uncertainty ahead of Dec. 31 is to “stay lean and keep yourinventories taut,” Sandy Cutler, chief executive officer ofindustrial equipment-maker Eaton Corp. in Cleveland, told aconference May 31.

Economists are predicting this trend will pick up through theyear. “A lot of people see the fiscal cliff as a 2013 story, butyou don't board up the windows when the hurricane is there, youboard up the windows in anticipation,” said Michael Hanson, seniorU.S. economist at Bank of America Corp. in New York.

Hanson sees U.S. growth decelerating to 1.3 percent in the thirdquarter and 1 percent in the fourth quarter as the European debtcrisis and worries over the U.S. budget increasingly weigh on theeconomy. Gross domestic product advanced at a 1.9 percent annualpace in the first quarter.

Recession Concern

Things would get worse next year if Congress allows all of thescheduled spending reductions and tax increases to take effect. Inthat case, a recession is likely, the non-partisan CongressionalBudget Office warned in a report last month.

The scheduled budget cuts haven't had much of an effect onfinancial markets, with investors preoccupied by the intensifyingcrisis in Europe. Sixty-one percent of the 234 fund managerssurveyed by Bank of America last month saw the euro region's debttroubles as the biggest concern in the world economy, more thanthree times as many who said that about the U.S. fiscal cliff.

In a sign of investors' equanimity, U.S. stocks have been thebest-performing major equity market in 2012, with the Standard& Poor's 500 Index up by more than 6 percent so far thisyear.

Such sentiment could shift if Congress doesn't act in the nextfew months to avoid the year-end budget precipice, said PeterFisher, senior managing director in New York at BlackRock Inc., theworld's largest money manager.

“The markets don't want to wait until Dec. 31,” Fisher, a formerFederal Reserve and Treasury official, told Bloomberg Television onMay 30. “Congress is going to have to wake up in October when themarkets start pricing in the uncertainty of a recession in2013.”

Lawmakers, for their part, said they don't anticipate much fromCongress until after the November election. The two parties arejust too divided.

Preferred Systems Solutions is among government contractorscoping with delayed procurements and agency cost-cutting, saidScott Goss, president and chief executive officer of the Vienna,Virginia-based engineering and information technology provider. Oneintelligence agency asked Goss to lower his charges on an existing10-year contract.

Feeling 'Squeeze'

“I'm feeling more of a pinch and squeeze than I ever havebefore,” Goss said. “As soon as they start these massive cuts,they're going to impact the economy.”

Defense contractors are “most fearful” of across-the- boardreductions that could spur as many as 350,000 job losses ifCongress doesn't act, said Cord Sterling, vice president of theAerospace Industries Association of America.

In the absence of guidance from President Barack Obama'sadministration about how the cuts would be carried out, companies“have to assume those go into place,” he said.

The prospect of cuts already is having a “chilling effect” onthe industry and Lockheed Martin Corp. and other companies may stophiring and training, Robert Stevens, chief executive officer of theworld's largest defense company, said in March on Capitol Hill.Last month he said that laws requiring advance notice of firingsmay prompt grim warnings in September and October.

Other companies have changed their hiring plans. RTIInternational Metals Inc. began building a plant in Virginia in2007, intending to hire more than 200 workers and devote half ofthe facility's capacity to defense programs, said Dawne Hickton,chief executive officer of the Pittsburgh-based titaniummanufacturer.

Defense cuts and the uncertainty surrounding the fate of the newJoint Strike Fighter changed the company's plans, causing it toscale back the size of the plant and curtail hiring.

“We've probably got about 50 people” at the facility, whichopened at the end of last year, Hickton said.

The fiscal cliff is a catch-all phrase for a confluence ofbudget measures coming to a head at the end of year. Chief amongthem is the expiration of tax cuts for income, dividends andcapital gains championed by former President George W. Bush. A 2-percentage-point cut in payroll taxes is also set to end.

If Congress does nothing, 82.9 percent of U.S. households wouldface tax increases averaging $3,701, according to the Tax PolicyCenter, a nonpartisan research group in Washington. More than 98percent of households earning more than $50,000 a year would payhigher taxes.

Defense Cuts

On the spending side, some $65 billion in automatic cuts are setto take effect in 2013 as part of last year's deal to raise thedebt limit. Half of the reductions will come from defensespending.

Besides the tax cuts, expanded unemployment benefits and aprovision that prevents steep cuts in Medicare reimbursement todoctors are scheduled to expire on Dec. 31.

All told, the steps on their own would reduce the federal budgetdeficit by $607 billion, or 4 percent of the gross domesticproduct, in the fiscal year starting Oct. 1, the CBO said. Theshortfall this fiscal year is projected to be $1.2 trillion.

Federal Reserve Chairman Ben S. Bernanke warned lawmakers onJune 7 that such a “severe” tightening of fiscal policy would “posea significant threat to the recovery” if it were allowed toproceed. He also has indicated that the Fed would be hard-pressedto offset the full effect of such moves on the economy.

Given the stakes involved, economists surveyed by Bloomberg Newslast month said they expect lawmakers to avert an economic declineby delaying or rescinding many of the spending cuts and taxincreases slated to take effect in 2013.

Even if Congress doesn't take steps to do that by the end of2012, the U.S. won't immediately lapse into recession, according toChad Stone, chief economist at the Center on Budget and PolicyPriorities. The Washington group advocates policies that benefitlower- and middle-income Americans.

“The economy will indeed start down a slope that couldultimately lead to a recession in 2013,” he wrote in a June 4report. “That's a far cry from the economy falling off a cliff andplunging immediately into a recession.”

Still, companies are hunkering down to prepare for the potentialfallout.

Cash Flow

Kimmie Candy Co. this month put on hold plans to add five or sixworkers to its 23-person payroll because of slowing sales growthand the political uncertainty in Washington, said Joseph Dutra,president of the Reno, Nevada-based company.

“For a small business like mine, cash flow is the biggestconcern,” said Dutra, whose company makes Choco Rocks and Sunburstcandies. “If you don't know where the economy is going and wherethe government is going on taxes, you don't want to take too manyrisks.”

Other companies are reacting in similar ways, according to JimMcCaughan, chief executive officer of Des Moines, Iowa-basedPrincipal Global Investors LLC, which works with some 30,000employers on their retirement benefit plans.

“What they've said to us actually in the last couple of monthsis we are slowing hiring because of the fiscal cliff and that'sreally their reasoning more than the European uncertainty,” he tolda conference on June 6. “It's more that Washington isn't doinganything about the tax rises that are scheduled to come.”

U.S. employers expanded their payrolls by 69,000 workers lastmonth, the smallest increase in a year and significantly down froman increase of 275,000 in January.

The impasse over the budget is taking a toll on the economy andwill reduce growth this year by about a half percentage point,according to CBO Director Doug Elmendorf.

“We think it's an issue now and will be increasingly an issue inthe second half of the year,” he told reporters last week.

His agency has been affected, too. Officials are unsure aboutwhether to replace workers who leave because it's impossible toplan on next year's budget.

“That must play out on a much, much larger scale with moresignificant enterprises than ours,” Elmendorf said.

Bloomberg News

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