November 1, 2012
As the hard-fought campaign moves towards an uncertain finale next week, President Obama and Republican challenger Mitt Romney have begun offering solid clues as to how they would defuse a looming year-end fiscal calamity that many experts fear could send the struggling economy back into a recession.
Washington is awash with speculation and anxiety about the looming fiscal cliff of massive tax increases and spending cuts that awaits Congressional action shortly after Tuesday’s election. While there are many scenarios for how negotiatons might play out in a sorely divided government, the path to resolution may be much simpler than many suspect once the votes are counted.
Obama envisions a $4 trillion bipartisan “Grand Bargain” of spending cuts, entitlement and tax reforms and tax increases on the wealthiest Americans to solve the country’s long -term debt problem while averting a jarring year-end panoply of expiring tax cuts and defense and domestic spending reductions totaling $607 billion. Obama’s last bid for a “Grand Bargain” was his failed secret talks with House Speaker John Boehner, R-Ohio, that collapsed in recriminations.
“It will probably be messy,” the president told the Des Moines Register last week. “It won’t be pleasant. But I am absolutely confident that we can get what is the equivalent of the grand bargain that I’ve been offering to the Republicans for a very long time.”
Romney is dismissive of grand bargains and opposes tax hikes on the wealthy. He says that if elected, he wants Congress and Obama to delay any permanent solutions until after the inauguration in late January, and has suggested he would be open to fixing the problem with a series of separate bills.
Both men favor derailing the more than $50 billion of defense cuts set to take effect automatically in early January under budget sequestration. The two also agree that a stopgap measure is needed before January 1 to temporarily extend the raft of Bush era tax cuts and other measures set to expire. However, Obama has signaled his intent to veto even a few months’ extension of tax cuts unless families earning more than $250,000 a year are made to pay higher rates.
THE TAX CONUNDRUM
Taxes have been the flash point in Obama’s dealings with Republicans during the past two years. Romney, Boehner and Senate Republican Leader Mitch McConnell of Kentucky insist that the Bush tax cuts be extended for all Americans, arguing that any increase in rates would discourage investments and job expansion by small businesses. Moreover, Romney has proposed further tax cuts of 20 percent across the board in exchange for capping tax breaks.
Whether Obama would make good on his veto threat remains to be seen, although he would likely find it difficult to defend that position if Romney and the GOP sweep to victory and claim a mandate for their economic and budget policies.
“If Obama is reelected, he will have to negotiate with a Republican House of Representatives whose leaders aren’t sure they can do business with him and whose views are diametrically opposed to his own,” said William Galston, a former senior policy adviser to President Bill Clinton. “So if Obama wants to make progress on fiscal questions or any other questions, he is going to have to consider hard compromises – that is to say the kind of compromise that all parties agree to something, pieces of which each party fundamentally disagrees with.”
If Romney wins, Galston added, “The Republicans will have a very strong incentive to agree to as little as possible -- for as short a time as possible -- until the White House is under new management. And then the question is how much of a price will Senate Democrats force them to pay for that short-term deal.”
Senate Majority Leader Harry Reid of Nevada, Sen. Charles Schumer of New York and other Democratic leaders are closely allied with Obama in arguing that the wealthiest 2 percent of taxpayers should pay more to help bring down the deficit while maintaining essential government services for the middle class. The Democratic Senate is a counterweight to the House and would be the only thing standing in the way of a Republican agenda if Romney beats Obama next week. If Obama and the Senate Democrats prevail next week, then the political status quo will be maintained at least for the next two years.
Amid dire predictions about the economic impact of going over the fiscal cliff, it’s important to remember that most leading economists say the odds of that happening are slim. Mark Zandi of Moody’s Analytics, in a report issued in mid-September, projected there was only a 15 percent probability of going over the cliff. He gave a 30 percent probability to Congress and the White House extending all current policies for a time – the “kick the can down the road” scenario. His most likely outcome – a 55 percent probability – is that some “middle ground” will be reached during the lame duck session.
RECESSION: HOW BAD, HOW FAST?
Even if Congress ignores the cliff during its lame duck session, most of its spending cuts, tax increases and cuts in physicians’ Medicare pay could be quickly reversed in the next session, which gets underway in mid-January. The non-partisan Congressional Budget Office’s most dire prediction – that the economy would contract by about 0.5 percent over the course of 2013 with unemployment rising to 9.2 percent from current levels – assumes those policies will be in effect all year.
The recessionary effects of the full “cliff” would take time to filter through the economy. And they could be easily reversed whenever the new Congress and president reach a compromise on taxes and spending. “The economy doesn’t go over a cliff immediately,” said Chad Stone, chief economist for the Center for Budget and Policy Priorities. “It starts slipping down a slope.”
Businesses, however, have a different problem. They’re in the final throes of budget planning, and that includes headcount. If they believe the rollbacks and tax increases will take place, layoffs are inevitable at the start of their fiscal years, many of which begin on January 1.
COMPROMISE IS INEVITABLE
The nature of that any compromise, whether reached during the lame duck or early next year, will depend entirely on the shape of the new Congress and who wins the White House. If Republicans win control of both houses and Romney is elected, the new administration could ignore the lame duck session and simply implement their own policies a few weeks or a few months into the New Year.
Those would probably include extending all the tax cuts except the payroll tax cut, extending the alternative minimum tax, removing tax benefits for the working poor and unemployed, and using some of that money to restore physicians’ Medicare pay. They could also work through the various budget and authorization committees to rapidly reverse the fiscal cliff spending cuts for the military while imposing larger cuts on the domestic side of the ledger. The House approved something along those lines earlier this year that had been drafted by Rep. Paul Ryan, R-Wis., Romney’s running mate.
That would have a much smaller impact on the economy than a full fiscal cliff scenario. According to a Congressional Research Service analysis, 19 percent of the reduced government expenditures and tax increases comes from cancelling the payroll tax increase and 5 percent comes from ending extended unemployment insurance. Not ending the Bush-era tax cuts and restoring the alternative minimum tax, on the other hand, reverses 44 percent of the fiscal cliff anti-stimulus.
An Obama win or the Democrats holding onto the Senate or both opens the door for compromise. If the Republican House refuses to pass any tax legislation that ends the high-end tax cuts, which the president has vowed to veto, the president and/or Senate can simply allow them to expire, which would largely solve the long-term budget deficit issues in one fell swoop since roughly 80 percent of the one-year $607 billion “cliff” comes from tax increases.
“Going over the cliff would really bring pressure on policymakers,” Stone said. On the positive side, “any tax changes [after that] would be a tax cut.”