Even if Democrats and Republicans reach a compromise, the so-called “fiscal cliff” (read: austerity crisis) should serve as a reminder of how dysfunctional Washington has become. The Dec. 31 deadline, after which a string of tax increases and spending cuts are scheduled to take effect, was created by the Budget Control Act of 2011, enacted as a compromise to resolve a dispute over the public debt ceiling. This day of reckoning, in other words, was never inevitable.
The fiscal cliff is not the product of the federal government’s “reckless” spending or borrowing. The dreaded Debt Collector has not come-a-knocking (in fact, interest rates on the national debt are at an all-time low). Rather, the fiscal cliff is a manufactured controversy – manufactured by Republican intransigence on raising the debt ceiling – and is intended to spark a political frenzy and create a scenario so economically painful as to force an eventual agreement. In other words, Congress, casting itself in the role of God, created a cliff, created a car, pointed that car in the direction of the cliff, got in that car, and then put the pedal to the metal. Now it is searching frantically for the ejection button.
Depending on the congressional response to the fiscal cliff, the Congressional Budget Office (CBO) has projected two fiscal scenarios for the years 2013 and 2022: (1) the baseline projection (i.e., follow current law) – i.e., Congress permits the Bush-era tax cuts to expire and spending cuts to be implemented; or (2) the alternative fiscal scenario – i.e., Congress “avoids” the fiscal cliff by repealing current law and replacing it with an alternative solution. If Congress followed current law and permitted the U.S. to go “over” the fiscal cliff, the changes would result in higher tax revenues and reduced spending, thus lowering the federal deficit. According to the CBO, tax revenue would rise to nearly 24% of GDP (current: 15.4% of GDP; historical average: 18% of GDP), the budget deficit would be reduced from an estimated 8.5% of GDP in 2011 to just 1.2% in 2021, and public debt would rise from 69% of GDP in 2011 to 84% in 2035. These changes, the CBO notes, would have positive long-term effects (i.e., relatively higher growth estimates).
But in the short-term, the effects could derail our economic recovery and destabilize the fragile global economy. In 2013 alone, the sum of the expiring Bush-era tax cuts and mandated spending cuts would result in approximately $500 billion to $700 billion in deficit reduction. That reduction, however, would likely cause real GDP growth to decline to 0.5% from 1.1%, creating a high probability of recession during the first half of the year. With Europe still “fragile,” another recession in the U.S. could destabilize the entire global economy and threaten economic chaos. In addition, due to the tax increases, the average family’s take-home pay would be reduced by more than 6 percent. Everybody in Washington, despite any rhetoric to the contrary, agrees that this scenario must be avoided, and that America must not go over the fiscal cliff.
The disagreements between Democrats and Republicans, then, have nothing to do with whether we should address the fiscal cliff, but in how we should go about doing it. As of this week, both Democrats and Republicans have made their initial offers. The White House estimates that its plan would reduce the federal deficit by $4.4 trillion over 10 years. This figure, it should be noted, includes the previously enacted spending cuts Congress passed in 2011 ($1 trillion), the savings from ending the wars in Iraq and Afghanistan ($800 billion), as well as interest payments on the national debt ($600 billion). Similarly, the House Republican leadership estimates that its plan would reduce the deficit by $2 trillion over 10 years, but this estimate does not claim previous cuts, war savings or interest costs toward that total. When compared with the same terms as the president’s offer, Republicans believe their plan cuts $4.6 trillion over the next decade.
With regard to the specifics, here is how the two proposals compare to one another, side-by-side:
- The Obama Plan: Increase revenue by $1.6 trillion over 10 years by raising tax rates. The plan would involve permitting the Bush-era tax cuts (2001 and 2003) to expire for individuals earning over $200,000 and joint-filers (families) who earn over $250,000 (the top 2 percent of American households). For those individuals, the tax rates would return to the Clinton-era levels of 36 and 39.6 percent, up from 33 and 35 percent. There would be no tax increases for individuals earning less than $200,000 and joint-filers who earn less than $250,000. Capital gains would be taxed at 23.8 percent (20 percent plus a 3.8 percent surtax related to the Affordable Care Act), up from 15 percent. The top rate on dividends would be consistent with the top marginal rate on ordinary income (43.4 percent; 39.6 percent plus the 3.8 percent ACA surtax), up from 15 percent. Estate taxes would be returned to 2009 levels. Limits would be reinstated on personal exemptions and deductions. Finally, Obama’s proposal would renew the 2-percentage point payroll-tax cut for middle-income taxpayers.
- The Republican Plan: Increase revenue by $800 billion over 10 years by eliminating unspecified tax breaks and loopholes. The plan would extend all of the Bush-era tax cuts (including those for the wealthiest Americans), keep the capital gains and dividend tax rates at 15 percent, and maintain the curent estate tax (which exempts estates up to $5.1 million and sets a top rate of 35 percent). The payroll-tax cut, however, would be permitted to expire, and unemployment benefits would not be extended.
- Medicare and Medicaid
- The Obama Plan: Cut $350 billion over 10 years from Medicare and Medicaid. The savings would come primarily from cost curbs to health care providers as well as lower Medicare drug costs. All of these cuts would be delayed one-year to give the economy additional time to recover.
- The Republican Plan: Cut $600 billion over 10 years from Medicare and Medicaid. The savings would come from unspecified cuts to health care providers, increasing the eligibility age for Medicare, and requiring wealthier Medicare recipients to pay more for their benefits.
- Social Security
- The Obama Plan: No proposal dealing with Social Security Benefits.
- The Republican Plan: Cut $200 billion over 10 years by replacing the government inflation measure for Social Security with a “chained CPI.” On average, the “chained CPI is 0.3 percentage points less than the current measure. This would reduce Social Security cost-of-living increases, thereby causing a greater portion of taxpayer income to be taxed at higher rates.
- The Obama Plan: Apply a new AMT patch and extend the “doc-fix,” thereby extending corporate tax credits for research and development and avoiding a 27 percent cut in reimbursement to medical professionals.
- The Republican Plan: No proposal dealing with the AMT/”Doc-Fix.”/li>
- Other Spending Cuts
- The Obama Plan: Cut $250 billion over 10 years from miscellaneous programs. Mr. Obama would leave in place the existing “caps” on agency operating budgets.
- The Republican Plan: Cut $300 billion over 10 years from miscellaneous programs. Agency operating budgets would also be reduced $300 billion over 10 years.
- Additional Spending
- The Obama Plan: $200 billion in new economic “stimulus.” This new stimulus would likely include helping borrowers who are “under water” on their mortgages and new spending on infrastructure projects, among other initiatives. Also included here is the extension of the payroll-tax cut and unemployment benefits.
- The Republican Plan: No proposal for additional spending.
- Debt Ceiling
- The Obama Plan: Eliminate the requirement that Congress pass future debt ceiling increases. Note that the debt ceiling is currently set at $16.4 trillion, which the federal government is likely to reach by mid-February.
- The Republican Plan: No proposal dealing with the debt ceiling, thereby continuing to require Congress to pass debt ceiling increases.
Following Obama’s proposal, House Speaker John Boehner (R-OH) argued, “the White House has to get serious.” And after the Republican counteroffer, President Obama rejected it as “out of balance.” Because these offers represented the opening salvo of increasingly intense negotiations, it is difficult to imagine the situation playing out differently.
After a hard fought election win, Obama is on the offensive. The Obama plan is laden with liberal priorities, and it is precisely the proposal you would expect from a Democrat coming off a resounding electoral victory. Obama campaigned on increasing revenue by raising taxes on the wealthiest two percent of Americans, and he is not backing down from that campaign promise. In addition, Obama’s proposal includes $200 billion in new economic “stimulus,” extends the payroll-tax cut and unemployment benefits, increases the tax rate on capital gains and dividends, and quiets concern over another debt ceiling fight. On the other hand, Obama’s proposal also includes significant concessions. Although the proposal does call for new stimulus, it also includes a total of $600 billion in spending cuts, a major portion of which will come from Medicare, drawing the ire of many congressional Democrats, democratic-supporting organizations and think tanks.
Similarly, the Republican plan is laden with conservative priorities. For example, the proposal calls for a more severe reduction in federal spending (interestingly, though, conservatives have attacked the proposal as not cutting spending enough), targets the social safety net by raising the eligibility age for Medicare and reducing Social Security cost-of-living increases, and keeps the Bush-era tax cuts for the wealthy intact (while at the same time eliminating the middle class payroll-tax cut and curtailing unemployment benefits). The only “concession” within the GOP proposal is a promise to raise $800 billion in revenue by eliminating unspecified tax loopholes, exemptions and deductions.
While nobody expected Republicans to lay down their arms and cede ground to the Democrats immediately, the Republican proposal is still not what you would expected from a party in disarray and smarting from an election in which they manifestly failed to achieve their goals. Republicans wanted a President Romney; instead, President Obama won the popular vote by nearly 5 million and pummeled Mr. Romney in the Electoral College by 126 votes. Republicans wanted to gain the Senate majority; instead, Democrats gained two seats. And while Republicans were able to retain control of the House, Democrats were able to pick up eight House seats. Republicans were only able to retain control of the House because of partisan gerrymandering – i.e., the drawing of congressional districts to maximize the number of majority districts for one party. After the dust had settled and the final votes were counted, it became clear that, despite remaining the minority, Democratic House candidates had received 1 million more votes than their Republican opponents.
Rather than laying out a proposal reflecting what he thinks Republicans want, Obama demanded that Republicans put up or shut up, a remarkable shift from previous negotiations. As the New York Times Editorial Page noted, the end result was a Republican proposal that “was a transparent attempt to appear responsive to Mr. Obama’s detailed proposal from last week, without doing any actual math or hard work.” Most of the Republican proposals were ripped straight from suggestions by Democrat Erskine Bowles at a hearing last year (Bowles quickly disavowed the Republican proposal). And many of the others involve deeply unpopular positions, bad policy, or “mathematically challenged” assertions.
For example, Americans overwhelmingly oppose, by greater than a two-to-one margin, increasing the Medicare retirement age. But apart from being unpopular, raising the Medicare retirement age is also terrible and ineffective policy. Such a change would cost individuals near retirement more, increase premiums for everyone on Medicare and people using the new ACA exchanges, and it would only save the federal government a modest amount of money (according to the CBO, $113 billion over 10 years). In addition, whereas Republicans want to extend the Bush-era tax cuts, they want to eliminate the payroll-tax cut. But according to the Economic Policy Institute, continuing the payroll-tax cut would create 1 million new jobs in 2013 at a cost of $115 billion, whereas maintaining the Bush-era tax cuts (all of them, not just for the wealthy) would create only 600,000 jobs at the higher cost of $202 billion.
Moreover, the quotation marks around the word “concession,” in reference to the Republican’s promise to raise $800 billion in revenue, were deliberate. Initially, note that that promise represents a significant change from the Republican’s negotiating position prior to the November election, when Speaker Boehner promised to raise $950 billion in revenue. Yes, that’s right. Republicans lost the election, and their offer was reduced. Then note that, while both proposals are purposefully vague on certain issues, there is a reason why congressional Republicans refused to identify the relevant tax loopholes and deductions they wish to eliminate. Rather than identifying them in the immediate down payment, Republicans plan to have the higher revenues identified by the relevant House committees next year. Our political leaders (including Mr. Obama) have oversold the idea that Washington could overhaul the tax code to both lower tax rates and reduce budget deficits. While it may be possible to do so, it is not simple, and it would certainly be controversial. In order to do so, and in order for Republicans to raise the requisite $800 billion they promise, they would need to erode the tax advantages for charitable contributions, and would have to target other exemptions (e.g., home mortgage interest) that have a significant impact on middle-income taxpayers. The point here is not that closing loopholes and overhauling the tax code is a bad thing, but that it is insufficient by itself to raise sufficient revenue without harming the middle class.
November has quickly become December, and we seem no closer to reaching a deal to avert the fiscal cliff. Panic, however, does not foster clear thinking. And as time passes, Republicans will find themselves increasingly boxed in by a controversy of their own creation. In manufacturing this controversy, Republicans placed a bet on the November election. Like Mitt Romney, they too “so wanted” a President Romney and a Republican controlled House and Senate. The fact that it didn’t happen is taking too long to sink in, and it is time for Republicans to consider another remedy, besides snake oil and magic beans, to cure our nations ills. By Dec. 31, we will know if this salient fact has sunk in. And whether or not they are serious about negotiating with the President, rather than forcing the President to negotiate with himself.