Dec 29 2012

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Breaching the Fiscal Cliff

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At the Edge of the Abyss

The encouraging words coming from the President and the leaders in Congress yesterday regarding the looming fiscal cliff were just that – empty rhetoric.

There isn’t going to be a deal before Monday.

And that is not so much a prediction as a diagnosis.

The truth is that given their universe-separated agendas, neither the President nor the congressional GOP have a political self interest in compromise before the 1st.

For President Obama, the simple truth is that to achieve his most cherished policy goals, he need only sit back and allow the clock to run out on December 31st.

Without lifting a finger, income taxes will go up on those who earn more than $250,000. Capital gains and dividend taxes spike up. Estate taxes go up, and defense spending is cut across the board. It is the “dare not hope for” Winter Solstice List of progressives, delivered on the 8th day of Christmas without so much as a vote.

The GOP calculus is very different.

Since tax rate increases represent a philosophical and political red line for the party, the only path to a deal before the 1st is a “grand bargain” that contains sufficient spending restraint, entitlement reform and tax code simplification to justify a rate increase.

Clearly this is what John Boehner was trying for in the earlier, more optimistic beginnings of negotiations with the Administration.

The difficulty in reaching this kind of deal, no matter how beneficial from a national policy perspective, can be measured by this cold reality; such a bargain would require the President and Democrats to negotiate against their own political self interest. Nothing save a profound act of political charity could compel POTUS to such a deal. Nothing in the President’s background, temperment or experience indicates he would do such a thing, even if there is longer term governing benefit.

The latest word on Friday was that Harry Reid and Mitch McConnell were going to huddle to hash out an “imperfect” and limited deal that could be put to a vote before midnight Monday.

Don’t bet the house on such an agreement.

Any deal that the Senate passes will necessarily include tax increases. House Republicans have already embarrassed Speaker John Boehner, and potentially threatened his speakership, by effectively killing a deal last week that would have increased taxes solely on millionaires. As a result, John Boehner is not going to bring any legislation to the floor that does not command the support of at least 217 members of his caucus, representing a bare majority in the House.

Despite all the clucking from the chattering class, Boehner simply cannot rely on Democratic votes to pass a tax increase that does not enjoy the political support of his caucus. It could mean the end of Boehner. He is, after all, up for re-election as Speaker on January 3rd.

Understanding all of that, McConnell has no incentive to agree to a deal that sets up House Republicans as the national foil for a cliff deal failure – handing the President and Democrats not only a huge policy victory, but a substantial political/public relations victory as well, and placing the Democrats in commanding position for the debt limit fight that begins in earnest on January 1st. More likely is a modest, last-ditch plan introduced by Reid that fails to convince 60 Senators of its merits, or the complete breakdown in talks that takes the nation over the cliff amid political gridlock and acrimony.

This leads to another, unspoken truth.

A deal on the underlying elements of the fiscal cliff actually becomes easier once the nation crosses over it, even with all the awful impacts cliff diving entails.

While it may look like childish semantics to the rest of the nation, the tax increases that take place automatically on January 1st change the nature of the political conversation in Washington. After New Year’s Day, everyone will be talking about tax cuts.

Republicans will again be on familiar ground, fighting for the greatest possible tax relief for the largest possible number of Americans.

And the sheer scope of the tax increases and spending cuts that occur on the 1st provide the fertile territory for a big deal that Mitch McConnell is legendary for shaping, and for which every Member of Congress will have a stake.

On the 1st, all the Bush tax cuts expire, meaning a tax increase for everyone, from poorest to richest. The payroll tax holiday will be gone too, meaning more financial hardship, particularly for lower income Americans. Millions of taxpayers will suddenly be subject to the Alternate Minimum Tax (AMT), dramatically increasing their tax bill. Medicare doctors will take a 30 percent cut in reimbursements, leading to a direct impact for Medicare patients, when doctors inevitably prioritize patients who pay full freight. The marriage penalty comes back to life as expanded child tax credits expire, and tax breaks for companies that invest in clean technology and R&D will also go away. And extended unemployment benefits expire, leaving 2.1 million Americans at the edge of the financial abyss.

There are also the immediate budget cuts of $110 billion for the remaining nine months of the ’13 fiscal year, split between discretionary domestic programs and defense. And of course, there is the debt limit, which the US will technically broach on December 31st, but whose real “drop dead” date is in early February.

In whole, the tax increases, spending cuts, program terminations and debt limit will become the political tools of epic horse trading that has the potential to accomplish a comprehensive settlement of fiscal issues that has eluded the feds since 2011.

There is already bipartisan agreement today to extend the Bush tax cuts for earners below $250,000. In addition, neither party wants to see millions of Americans taxpayers arbitrarily subject to the AMT. Same is true with the “Dr. Fix” – there is no appetite to take on AARP when grandma is frozen out from her medical care.

Extension of unemployment benefits, the payroll tax cut, tax breaks for corporations, spending cuts and the debt limit represent leverage in certain aspects to each party. For instance, raising the debt limit in return for binding reforms in entitlements (changing the inflation calculation and raising the eligibility age) is one possible deal.

Other deals are in the offing.

Of course there will be pandemonium.

January is likely to be a very tough month for Washington and the nation, as the stock market copes with the reality of uncertainty, and consumers retrench in fear. A weak fourth quarter, and the reality of cliff diving could have a real impact on the economy in the opening weeks of 2013. Growth may falter, unemployment may spike.

But the truth of the cliff is that with the exception of payroll taxes and unemployment benefits, nothing is immediate.

The budget cuts for FY 2013 represent 8.5 percent of non-defense discretionary spending ($55 billion in a $647 billion budget). Agency and department managers who have done their jobs properly have structured required, potential, cuts for later in the year, and in a manner that does not impact their primary mission. The same is true for DoD, which takes a 7.8 percent hit for the remainder of this year. My own informal (and unscientific) review of the impact of the defense cuts, shows program managers planning on instituting program retrenchment in March or later; plenty of time for Congress to come to a deal.

In addition, keep in mind that tax changes that occur on January 1, 2013 will impact tax returns due April 15, 2014.

Despite the media hype about the coming fiscal apocalypse, IRS agents are not going to be knocking on doors on Wednesday morning, expecting a pro-active check. Any comprehensive deal will almost certainly be reached by the end of February, and it is virtually impossible to see any such deal being cut that is not retroactive to December 31st.

The actual impact on taxpayers – at least for those making less than $250,000 – should be, after an unnerving few weeks early in the year, ultimately negligible.

Which is not to say that cliff diving is forgiven or excused or readily permissable. Real people – families with children, are going to be hurt. Those least able to get by month to month will be the first to be exposed. Jobs may go unfilled, projects unfunded. That will all have an impact.

But it is equally important to remember that the culprit here is not the government, despite all of its obvious dysfunction.

Politics, ultimately, is the art of the possible.

In 2011, recognizing the profound – unbridgeable – differences between the President and congressional Republicans that gridlocked the capital, terrified Wall Street, slowed economic growth and infuriated citizens, leaders put together the best deal that was achievable, punting the hard decisions until after November 2012. Implicit in the deal was the notion that voters would settle the political dispute, sending to Washington a team that could govern in 2013.

But after eighteen months and billions of dollars spent on campaigns, voters sent back to Washington the very same teams that triggered the budget crisis to begin with.

You get what you vote for.

It is hard medicine, but if you are furious with Washington on January 1st, go look in a mirror.

You only have yourself to blame.




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