WASHINGTON Washington has steered clear of severe austerity measures for now, reducing the risk of recession, but a clutch of U.S. tax hikes will nevertheless be a drag on economic growth this year.
The U.S. Congress approved a deal late on Tuesday to scale back some $600 billion in scheduled tax hikes and government spending cuts known as the "fiscal cliff."
Analysts said the package at least marked a temporary reprieve for the economy, and investors charged into U.S. stocks, pushing the Standard & Poor's 500 up 2.5 percent on Wednesday.
However, the legislation, which is expected to be signed into law soon by President Barack Obama, will raise taxes on most Americans through a hike in the payroll tax used to fund Social Security pensions for the elderly.
Economists say the U.S. economy would likely grow much more quickly if the government was not raising taxes.
The payroll tax hike alone - which comes from the expiration of stimulus measures enacted to fight the 2007-09 recession - could push the average household tax bill up by about $700 this year, according to estimates from the Tax Policy Center, a Washington think tank.
That will likely reduce consumer spending and subtract about three quarters of a percentage point from economic growth, said Joseph LaVorgna, an economist at Deutsche Bank in New York.
The package will also raise income tax rates for households making over $450,000 a year, although rates will remain at 2012 levels for everyone else.
The other modest tax hikes, including a tax on wealthy households to help pay for Obama's 2010 healthcare reform law, could shave another quarter of a point from growth.
"We are still getting some fiscal drag this year," LaVorgna said.
Even so, the tenor of the deal was widely anticipated by economists in financial centers like Wall Street, and appears to support forecasts for economic growth of around 2 percent this year.
Barclays Capital said it was holding its growth forecast for this year at 2.1 percent.
A Reuters poll of analysts in December produced a median forecast for 1.9 percent U.S. economic growth in 2013.
"There seems to be a collective sigh of relief," strategists at Brown Brothers Harriman wrote in a note to clients. "The full force of the U.S. fiscal cliff - (which) could have dragged the world's largest economy into a recession - has been averted."
The Congressional Budget Office had estimated that completely running over the fiscal cliff would have caused the economy to contract 0.5 percent this year. The full brunt of the cliff would have hit the average U.S. household with about an additional $3,500 in taxes this year, according to the Tax Policy Center.
Still, U.S. lawmakers only agreed to delay scheduled cuts on government spending on the military, education and other areas for another two months.
Many economists think ongoing talks in Congress will eventually lead these spending cuts to be put off until next year, presumably once lawmakers reach a deal to reduce spending over the longer term while granting the government authority to increase the national debt.
Then again, they might not reach a deal, and the planned spending cuts would then cut deeply into economic growth in the second half of the year.
"While we retain our 2013 GDP forecast, we also retain the view that fiscal policy presents downside risks to growth," analysts at Barclays said in a research note.
Some economists noted that tax policy now looks more stable for the majority of Americans, removing some of the uncertainty that may have held back spending by consumers and business in recent months.
At the same time, with an axe still hanging above billions of dollars in government spending, many businesses are likely to remain cautious.
Analysts say financial markets are likely to remain on tenterhooks until Congress raises the nation's $16.4 trillion debt ceiling, which the U.S. Treasury confirmed had been reached on Monday.
The government likely will need to raise the debt ceiling by February or March to remove the risk albeit remote, of the country defaulting on its debt. Such an extreme scenario would likely make it more expensive for governments and companies alike to borrow money, hurting the economy.
"We have some more certainty, but there are still quite a few questions left to be resolved," said Dana Saporta, an economist at Credit Suisse.
(Additional reporting by Jonathan Spicer in New York; Editing by Leslie Adler)