Congress returns today to another self-created economic crisis.
There will be a lot of high drama on this before they go home for
Christmas. Congress has built a mountain of debt, scaled the top,
and found that the road back down leads only to a cliff. Now the
lemmings — like Wile E. Coyote, scrambling on thin air — are
wishing for a safety net for themselves — and, theoretically, our
economy — to catch them before the economy tumbles into a deep
recession on January 1.
Before we can understand what’s going on in the back-room
negotiations, we have to examine the crisis. What is it, how bad is
it, and how can it be resolved?
The “fiscal cliff” is a creation of Congress and President
Obama. They’ve already enacted, primarily in the so-called “Budget
Control Act” of 2011, a whole raft of economic measures that will
go into effect on January 1 unless Congress and Obama can agree on
ways to prevent our economy from going over the fiscal cliff they
created.
In short, here’s what will happen on January 1 unless the lame
ducks and Obama make a deal.
First, the Bush-era tax cuts will expire. Which means, for those
of us who pay taxes, that the rates will rise from the current
10-35% to 15-39.6%. Long-term capital gains taxes will rise from 15
to 20%. Dividends, now taxed at a lower rate than regular income,
will be taxed at the regular income rate.
Second, there are the Obamacare taxes. Investment income will be
subjected to a new, and additional, tax of 3.8% to fund Obamacare
(and advanced medical equipment, such as CAT-scan machines, will be
subject to another separate tax; there’s also the “Boehner” tax on
tanning beds).
Third, the estate tax will rise from 35% to 55%. So if your
estate is valued at more than $5 million, your heirs would benefit
greatly if you die before the ball falls in Times Square on New
Year’s Eve. The new rate will be imposed on much smaller estates,
those over $1 million.
Fourth, the wonderful world of sequestration will come upon us
in January if Congress and Obama don’t act. Sequestration will cut
government programs across the board — damaging our defense,
perhaps irreparably — and reducing some domestic programs. Social
Security and Medicare are exempt from sequestration because the
Dems and the unions insisted. Those two programs, of course, are
what drives our national debt. The debt cannot be reduced unless
they are tamed.
Finally, the payroll tax reduction, another “stimulus,” will
expire on December 31.
As the Congressional Budget Office has forecast, if we fall off
the fiscal cliff and all these tax hikes come into effect, we’ll be
in a below-zero growth economy. Which, by definition, is a
recession. Unemployment will grow much higher because industries
will lay off many more people than have already been cut. In
defense alone, one George Mason University study says that about 1
million jobs will be lost due to sequestration over the next
decade.
All told, that’s a pretty high cliff to run off.
Congress — looking for an easy escape — will probably try to
concoct another “if-then” deal of the kind I
warned against in 2011 when they were crafting the Budget
Control Act. To recap, an “if-then” deal is when the Republicans
agree to something that takes effect immediately — such as a debt
ceiling hike or a tax increase — in return for a Democrat promise
to agree to future budget cuts. And, if the past umpteen such deals
are a predicate, when the time comes for the Dems to agree to
something that will actually happen, they renege.
Before they even get to the “if-then” deal, Congress is
apparently considering an increase in federal spending in the
fiscal cliff negotiations. Yes, you read that right. In the fiscal
cliff negotiations, our wonderful congressional leaders may end up
increasing government spending.
Thanks to Sen. Jeff Sessions (R-Ala), ranking Republican on the
Senate Budget Committee, we know some of the details. In a November
20 letter to McConnell, Boehner, Reid and Pelosi, Sessions raised a
big red flag.
“It is my understanding,” he wrote, “that some of the items that
may be raised in your fiscal negotiations would increase spending
above the levels projected under the Budget Control Act and
therefore need to be offset through reductions elsewhere.” The
items Sessions cites are a one-year continuation of extended
unemployment benefits, a continuation of the 2% payroll tax
reduction, and modification of the rates paid to physicians under
Medicare, which would increase federal spending to a total of $137
billion more than the Budget Control Act allows.
Any increase in federal spending would be simply bizarre in any
fiscal cliff deal. For that reason alone we should expect it to
happen. And the dealmaking is likely to get a lot worse.
The vultures are already circling. One example already leaked is
that some are advocating an increase to the federal gasoline tax.
For every one of these vulture tax initiatives that is reported,
there will be thirty we don’t hear about until after the deal is
made.
The outlines of a fiscal cliff deal are easy to forecast, though
the details are not. Obama is determined to raise taxes on the
rich, and he will probably succeed. His success will be
attributable to the urgency that Republicans helped build into the
earlier legislation. If they hadn’t agreed to the last “if-then”
deal in 2011, and hadn’t agreed to the automatic nature of the tax
hikes in January, they might have avoided this mess. But now they
have little leverage: Obama is newly reelected and the calendar is
inexorably moving toward January.
Middle class taxes will rise as well, but will be hidden under
various disguises such as the Obamacare taxes, dividend taxes, and
such. To let the Republicans save face, the Dems will agree that
it’ll all be stuffed into another pillow sack “if-then” deal.
The Republicans will agree to some tax hikes now in return for
entitlement reforms that won’t take effect for years to come. The
unions — who are demanding no change in entitlement programs —
will feign outrage at one part of the deal that pretends to make
future cuts knowing well that the Dems will not let them happen.
And the entitlement program reductions — maybe in the form of
“means testing” or indexing to lower rates — will be put off for
five or ten years.
The Republicans will give up more than they should. “What else
can we do?” they’ll wail. Actually, a lot can be done if they’re
willing to take the risks that come from failing to make a deal.
It’s a risk they have to take.
First and foremost, they have to refuse another “if-then” deal.
Anything they agree to — which shouldn’t include any tax hikes or
the expiration of any prior tax cuts — must all take effect now.
To the extent that future cuts to entitlement programs and any
other government spending are included, these cuts should have to
take effect on a date certain. And — to prevent any Democratic
backpedaling — the legislation should provide that any
modifications to the entitlement reductions would have to survive a
supermajority vote in both the House and the Senate. By so doing
they can make any future action to cancel the cuts very hard to
do.
The flip side of this is the sequestration problem. Even if the
fiscal cliff deal changes sequestration for 2013, there are still
nine more years of sequestration coming — automatically — unless
the sequestration mechanism is changed. The Dems don’t want to stop
sequestration on defense, but they do want to stop it on domestic
programs. This isn’t going to be easy, but the Republicans need to
repeal the whole sequestration mechanism so we don’t have to do
this again and again.
And, lastly, the House Republicans need to keep in mind that
come March, they’ll have to face another debt ceiling increase.
They will have a lot more leverage then than they do now, so it’s
important to not give in. It’ll be easier to force real spending
cuts in the next round if — and only if — they are willing to
risk a government shutdown. That’s the only real leverage they
have, and — to date — they’ve been unwilling to take the
risk.
