The so-called fiscal cliff is one of those rare issues where everyone has an incentive to predict the worst. Barack Obama thinks it will force Republicans to accept higher taxes on the rich, Republicans think they can back him into a corner and force him to cave to their demands as they did two years ago, and businesses and consumers are wary that the still-fragile economy may take a nosedive. Figuring out how this will play out is Washington’s favorite parlor game right now, so let’s play.
Starting with Obama, he is obviously coming off a very sweet election victory. Although Republicans are doing their best to diminish its significance, the fact that he won two victories in a row with better than 50 percent of the total vote puts him in elite company. In the postwar era, only Dwight Eisenhower and Ronald Reagan accomplished that feat. And the fact that Democrats picked up seats in the Senate, when they were expected to lose net seats, is icing on the cake. Democrats even got a slight majority of all votes for the House, even though they failed to retake control due to gerrymandering by Republican state legislatures.
Obama knows that his record of accomplishment on the budget is thin. He was hamstrung by the economy’s weakness and implacable GOP opposition and totally caved to Republican demands and simply extended the Bush tax cuts for two years in 2010 without making any real effort to let those at the top expire, as he had demanded.
I thought that was the right decision given the political and economic circumstances. But there’s no question that Obama paid a price for showing weakness in the face of his enemy. It encouraged Republicans to double-down on their opposition to anything Obama proposed – even when they agreed with it.
Thus in the Summer of 2011, Republicans refused to raise the nation’s debt limit, creating a financial crisis that still haunts financial markets. They were close to negotiating a deal for $800 billion in revenue increases in exchange for deep spending cuts when a parallel effort by a group of Senators called “The Gang of Six” upped the ante. Obama endorsed the new, much higher revenue plan of $1.2 trillion and Republicans walked away.
Instead, Republicans accepted “sequestration” – automatic spending cuts of $1.2 trillion divided equally between domestic and defense programs. The number of congressional Republicans willing to actually accept even a penny of defense cuts can probably be counted on one hand; they just assumed that a congressional super committee would come up with alternative spending cuts that made more sense than the meat-ax approach that was enacted into law.
But the super committee collapsed because, once again, Republicans remained subservient to their ultra-wealth contributors and refused to accept even a penny of tax increase. They also knew that every single candidate running for the Republican presidential nomination had rejected $10 of spending cuts for $1 of tax increase at a debate in Iowa.
So now a major part of the fiscal cliff is a spending sequestration that Republicans enacted as their price for raising the debt limit and that many now desperately want to reverse, but can’t say so for fear of looking like complete fools. Ever since the day Obama took office, they have said that government spending inhibits economic growth and spending cuts are stimulative, but faced with the reality of actual spending cuts Republicans backtracked in full retreat.
All during the campaign, Republicans ran advertisements in battleground states like Virginia trying to blame Obama for defense cuts, which they said would cost hundreds of thousands of jobs. That took chutzpah and it didn’t work. Voters understood perfectly well that if defense cuts cost jobs, then so do domestic cuts. And if spending cuts cost jobs then spending increases can create them.
Of course, the other big part of the fiscal cliff is an automatic tax rise. But it’s not really a tax increase, just the expiration of tax cuts that Republicans themselves enacted with expiration dates. They rejected the idea of permanent tax cuts because that would have required them to negotiate a deal with Democrats, which Republicans categorically rejected. So on this issue as well, they are hoist with their own petard.
Now Obama holds all the cards and he knows it. All he has to do is nothing and all the legislation Republicans themselves enacted will take effect on January 1 and constitutes the fiscal cliff. Republicans are desperate to head this off because they know their negotiating position will evaporate once the debate turns to raising spending and cutting taxes to undo the fiscal cliff.
Thus Republicans and their allies in the business community want action before the end of the year in Congress’s lame duck session. But as budget expert Stan Collender explains, this is practically impossible. There simply isn’t time to do everything that needs to be done.
Moreover, Democrats in Congress have a strong incentive to wait until the next Congress for final resolution of the fiscal cliff. They picked up seats in both the House and Senate and will be in a stronger position come January. Republicans also know this.
For these reasons, I think it is almost a certainty that the fiscal cliff will take effect as scheduled. But I am far more sanguine than most economists. The dire forecasts of a sharp economic slowdown assume that the spending cuts and higher taxes are in effect for all of 2013 and after. A temporary fiscal cliff is no big economic problem, especially if businesses and financial markets are assured of a quick reversal, which is almost a certainty. All the hand-wringing is pure political theater.
How soon the fiscal cliff will be resolved and on what terms is entirely up to Republicans. If they back away from their no-tax-increase-ever position and negotiate with Democrats, the pieces can fall into place quickly. I don’t see any problems on the spending side that cannot be resolved; taxes are the sticking point. Only if Republicans are willing to walk the plank for the ultra-wealthy is there an economic danger. I don’t think that will happen.