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To Avert a Fiscal-Cliff Catastrophe, Someone Has to Blink To Avert a Fiscal-Cliff Catastrophe, Someone Has to Blink

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Magazine / ELECTION 2012: THE LAME DUCK

To Avert a Fiscal-Cliff Catastrophe, Someone Has to Blink

Can either party be convinced that there is a difference between a lame-duck surrender and a lame-duck compromise? Probably not.

(illustration: paul slater; represented by bernstein & andriulli)

photo of Nancy Cook
November 8, 2012

President Obama has been awfully consistent. Since 2008, before he was elected president, he has vowed to help pay down the deficit by taxing the wealthiest Americans. Even the language remains the same. “It is true that my friend and supporter Warren Buffett, for example, could afford to pay a little more,” Obama said during a 2008 debate against his Republican challenger, John McCain.

Then it was one among many policy proposals. This time, it became the centerpiece of his fiscal plan, in a race dominated by the fiscal crisis and the recession’s aftermath. Obama’s reelection campaign argued that the rich should pay a greater share of taxes and that the Bush-era cuts should expire for the top 2 percent of earners. Exit polling from Tuesday’s election shows that a majority of voters agreed with Obama: 60 percent supported the idea of higher taxes on household income above $250,000.

Now that Obama’s last election is behind him, he is unlikely to change his mind. “For the president and the administration, this represents a red line,” says David Kamin, the president’s former special assistant for economic policy who is now a professor at the New York University School of Law. A balanced deficit-reduction package—one that does not eviscerate domestic programs—demands new revenue, so “the administration is going to do all it can to hang tough.”

 

But Republicans famously revile new taxes. While some GOP members of Congress say they’re open to new revenue, few—if any—say it should come from higher income-tax rates. And they are surely just as adamant as the president.

Both parties pledge that they don’t want to plunge from the fiscal cliff—the more than $500 billion in automatic tax hikes and spending cuts scheduled to kick in with the new year. The tax changes alone would affect roughly 90 percent of Americans, according to the nonpartisan Tax Policy Center.

But to avert catastrophe, someone needs to blink.

Since Tuesday, the two parties have been acting conciliatory (even if Obama’s victory gives him a great deal of leverage over Republicans who really don’t want the tax cuts to expire). House Speaker John Boehner and Senate Majority Leader Harry Reid talked on Wednesday about the need to cut a deal. “It’s better to dance than to fight,” as Reid put it. But besides the happy talk, it’s not clear what, if anything, the election has changed. “We have the same cast of characters. We have the same problems. Are we going to get a different result?” asks Douglas Holtz-Eakin, the former director of the Congressional Budget Office and now president of the conservative American Action Forum.

A different result means a large-scale compromise, and that’s one possibility for the lame duck. It is exceedingly remote. Observers think a smaller-scale compromise, however, might be within reach. The administration and Congress could come up with the framework for a deal—with specific targets—that temporarily avoids the sequester, extends the majority of the Bush-era tax cuts, and promises to tackle a grand bargain, as well as tax reform, in 2013. “The key resides in both parties understanding the difference between surrender and principled compromise,” Holtz-Eakin says.

So far, the parties have not acquired that understanding. That’s why another scenario may be more likely: a swan dive off the fiscal cliff after weeks of negotiations and tense wrangling. This would rattle the financial markets and vex a business community already horrified by political brinkmanship. But it would also give the two parties a new starting point for negotiations. Democrats could agree to some Medicare changes in return for additional revenue and higher rates on either individual or investment income; Republicans could negotiate upward the definition of “upper earner” and realize a historic entitlement reduction. That way, they could each say they had gotten what they wanted.

Until then, say experts, neither party may be able to declare victory. Obama has been on the record for four years insisting on a “balanced” solution, and Republicans have tax cuts written into their party’s DNA. How could the players see a difference between surrender and principled compromise when there may be none?

THE FRAMEWORK

Agreeing on the elusive “grand bargain”—or at least the contours of one—is the best-case scenario. It would allow Congress and the administration to reassure financial markets and the business community that they can work together. It would give lawmakers more time to delve into the details of tax policy, spending, and health care in a more meaningful way. Most significantly, it would not plunge the U.S. economy back into a recession. CBO estimates that going over the cliff would slow economic growth to 0.5 percent, while extending the tax cuts and deferring sequestration would lead to 4.4 percent growth.

The framework would have to be specific and enforceable to make it stick. This would include targets for revenue, an agreement on the top income-tax rate for individuals, and an understanding by both parties about how progressive the tax code should be. A framework must also include a penalty—something like sequestration—for failing to follow through. (Otherwise, Washington could keep punting for years.)

Under this scenario, lame-duck negotiators could quickly nail down some cheaper pieces of business: a patch that prevents the alternative minimum tax from hitting the middle class, the annual Medicare “doc fix,” and corporate tax-break extensions to appease the business community. Behind the scenes, some congressional staffers in both parties have also been working on a plan to temporarily undo the sequester’s most immediate $109 billion in cuts by offering up a down payment of $55 billion in savings.

Then the hard work of constructing a grand bargain would begin. In an interview with the Des Moines Register, Obama declared an opening position during his campaign: He wants $1 in revenue for every $2.50 in spending cuts. The term “revenue” is key. “The administration has been clear that they’re open in getting additional revenue from people at the top by ways other than raising the top rate,” Kamin says. “But if you agree to a top rate that is too low, it will be extraordinarily difficult to enact legislation that achieves your revenue goals by broadening the base, simply because cutting some of those tax expenditures may prove to be politically impossible.”

Republicans so far profess an open mind on “revenue,” which could allow a larger and more lasting deficit-reduction pathway: tax reform. Congressional Republicans and administration officials have all said in the last year that they want it. “By working together and creating a fairer, simpler, cleaner tax code, we can give our country a stronger, healthier economy,” Boehner said at a press conference on Wednesday. “A stronger economy means more revenue, which is what the president seeks. Because the American people expect us to find common ground, we are willing to accept some additional revenues via tax reform.”

Politically, this scenario behooves everyone, since it casts Congress and the White House as partners willing to engage in a major budget overhaul in 2013. It is still, however, the less likely outcome.

THE PLUNGE

The far more likely scenario for both parties is a swan dive over the fiscal cliff. The election gave Obama some leverage, especially since the Democrats retained control of the Senate. But House Republicans also kept their majority. Both parties view the status quo as an affirmation of their power. “The president feels like his mandate from a slim margin of victory is to raise taxes,” says a Republican Senate aide privy to GOP discussions. “A razor-thin margin will not change the principles of the Republicans.”

A plunge would follow weeks of behind-the-scenes negotiations, public political posturing, and pressure from outside groups—both political and business ones. And it would surely shake the nation’s confidence. But it might not be all bad.

True, from an economic standpoint, it would turn deficit reduction into a de facto program of austerity, just as the unemployment rate is sinking and the economy is recovering. But from a purely political standpoint, the cliff dive would allow lawmakers to negotiate with a clean slate. Neither party likes a recession per se, but they may both dislike one less than they dislike surrendering their entrenched tax positions.

The fresh start would allow Republicans and Democrats to cut a deal appealing to both parties. As soon as the Republicans reinstated a majority of the 2001 and 2003 tax cuts, they could sell it to their base as a huge windfall: They succeeded in cutting taxes! They could also nudge the Democrats to tweak entitlement programs such as Medicare and potentially Social Security—another selling point with the GOP base. (Democrats may agree to some changes there, but they will be most reluctant to cut programs for the poor, such as Medicaid and food stamps.)

Similarly, the Democrats could use the fiscal-cliff jump as a way to enact Obama’s campaign promises to tax top earners. The Republicans would have to agree to an increase in revenues—not just from future economic growth—and this, in turn, would allow Democrats to say they had fulfilled their campaign pledge and helped to level the playing field.

It’s even possible that, if both parties concoct a deal quickly, they can mitigate the economic effects. But a prolonged battle (during which the spending cuts and tax hikes stay in place) would enervate the economy and sap the confidence of consumers, businesses, creditors, and other countries.

It’s hard to see the route to a quick deal—especially one before the New Year’s deadline—because the players remain the same and the party lines are as extreme as ever. The president did call all four congressional leaders after the election to talk about the fiscal cliff; Obama, Boehner, and Reid spoke this week in a much friendlier tone than they have in the past about the need to compromise. But the substance has not shifted at all since the failed super committee and the epic battle in 2011 over the debt ceiling.

Pabulum about open-mindedness and summits at Camp David will not unify the parties over the next six weeks. Which may mean one thing: a jump over the cliff into the great unknown that hopefully sometime produces a compromise.

This article appeared in print as "Game of Chicken."

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