The eleventh-hour agreement on taxes that President Obama struck with congressional Republicans may have been the best deal the two sides could have reached without actually tumbling over the fiscal cliff. But no one should underestimate how much of a missed opportunity it represents.
The deal stands as the rare event that could simultaneously set back the goals of the left, right, and center. The expiration of the tax cuts passed under George W. Bush created the best chance for Democrats to significantly increase federal revenue—and, less obviously, for Republicans to limit spending by linking such cuts to more revenue in a grand bargain. Instead, by permanently extending so much of Bush’s tax cuts, the deal undermines those twin priorities of the Left and the Right, along with the centrist goal of reducing deficits and controlling the debt.
Even with the most visionary political leadership, stabilizing Washington’s finances won’t be easy. The number of seniors is projected to double over roughly the next three decades, unavoidably boosting budgets for Social Security, and especially for Medicare and Medicaid. Under that demographic pressure, the only way to escape unsustainable deficits, or to avoid spending on the old entirely eclipsing investment in the young, will be to raise more revenue from taxes and to slow the growth of entitlements.
Yet the fiscal-cliff deal compounds both of those challenges. The impact on taxes is the most apparent. The deal did raise about $600 billion in new revenue by allowing the Bush-era tax-rate cuts to expire for the wealthiest families. But that modest benefit came at the huge cost of making permanent 82 percent of Bush’s 2001 and 2003 tax cuts.
That’s an extraordinary reversal for the Democratic Party. In 2001, almost three-fourths of Senate Democrats and 85 percent of House Democrats voted against Bush’s tax-rate reductions. In the decade after Bush signed those cuts, the number of Americans with jobs and the median family income both declined, while the federal deficit soared—a 10-year record of economic futility unmatched since the Depression. Yet Obama and congressional Democrats agreed to extend those reductions for all but the families earning at least $450,000 annually, at a cost of $762 billion over the next decade, according to the Joint Tax Committee.
The deal’s treatment of the 2003 Bush initiative, which cut taxes on income from dividends and capital gains, was even more striking. In the House, Democrats at the time voted 198-7 against those cuts; Senate Democrats opposed them by 46-2. Yet the fiscal-cliff deal left those reductions undisturbed for families under $450,000 and barely nicked them for those earning more, at a cost of nearly $300 billion over the next decade.
Add a significant rollback of the estate tax and the extension of assorted tax credits, and the deal sets Washington on track to raise federal revenues equal to about 19 percent of the economy over time. That’s in line with historic averages, but not enough to maintain any fiscal balance as the gray tide inescapably swells spending. (Demography, not ideology, guarantees that Washington will consume more of the economy in future decades.) “Whatever the politics may have dictated, it’s very unfortunate that the bulk of the tax cuts were made permanent,” Peter Orszag, Obama’s first budget director, said in an e-mail. “That locks in a revenue base that is unlikely to be sufficient.”
Obama hopes to compel Republicans to accept additional revenue (through loophole closing) by insisting on it in any further deficit-reduction measure. But he’ll never have as much leverage as he did when he could have obtained more revenue by allowing the Bush tax cuts to expire and then negotiating over what to restore. Appearing on last Sunday’s talk shows, Senate Republican Leader Mitch McConnell practically ran out of synonyms to insist that discussion of more taxes was now “finished. Over. Completed.… Behind us.”
Obama will be stalemated if Republicans hold to that position. But, ironically, so might they. The GOP can’t pass entitlement reform without Obama’s involvement. But the price of his involvement is further tax increases that the GOP (as McConnell’s comments suggest) probably can’t accept after the conservative uproar against the fiscal-cliff deal. The GOP’s best chance to persuade Obama to offer cover for meaningful entitlement restraint was to couple it with a big rollback of the Bush tax cuts; for Obama, the reverse dynamic was true. The revenue generated by the end of the Bush tax cuts was the grease that could have smoothed a deal; without it, both parties may be perpetually grinding gears.
Republicans now expect that Obama will accept further spending cuts if they threaten to shut down the government or breach the debt limit, but experience dating back to Bill Clinton’s presidency says they are overestimating their leverage. The two sides may be doomed to little further progress on revenue or spending—and thus, mountainous deficits stretching toward the horizon. Both parties may rue squandering the opportunity that the end of Bush’s tax cuts offered to set a new course.
This article appears in the January 12, 2013 edition of National Journal Magazine as A Fiscal Fumble.