It Only Gets Worse From Here

Speaker Boehner speaking with President Obama (Source: CNN)

The deal to avert the fiscal cliff was a major development in the budget battles that have been going on for the last two years. It raised taxes for the first time in 20 years. It split the House and Senate GOP unlike anything in recent memory. And perhaps most noteworthy, it passed the Republican-controlled House on the backs of Democrats without a “majority of the majority”–the first time in over a decade such a thing has happened. Unfortunately, it is hard to argue that this deal is anything but a bad one. Whether you are a liberal, conservative, or a moderate, there is plenty to hate here. Before that, let’s quickly recap the big things that the deal does:

  • Makes the Bush Tax Cuts permanent for the first $400k of income
  • Allows the Bush Tax Cuts on income above that level to expire
  • Taxes Capital Gains and Dividends at a rate of 20% for income over $250k
  • Taxes Estates over $5 million at a rate of 40%
  • Permanently patches the AMT
  • Extends Emergency Unemployment Benefits for another year
  • Delays the Sequester two months (to when we hit the debt ceiling)
  • Renews various credits and deductions

A breakdown of the deal’s fiscal impact (Chart by The Committee for a Responsible Federal Budget)

On its face, this seems like an OK deal. Democrats get some tax increases on the top 1% and a small amount of stimulus spending, Republicans make the remaining tax cuts permanent and delay sequestration. The problem is that in the context of the budget battles of the last two years, this deal sets both sides up for a massive failure in a few short months.

If you remember, the fiscal cliff was not a naturally occurring economic phenomenon: it was an artificial crisis designed to force compromise and substantive action. I explained the origin of the cliff in a blog post a month back, but the short version is that the combination of blind spending cuts and $5 trillion in expiring tax cuts were supposed to be replaced by a comprehensive “grand bargain” that both sides could agree to. Going over the cliff was supposed to be a gun at the head of Congress to force them to act. But instead of making a deal or pulling the trigger, they created a much more deadly cliff in just 2 months.

If no deal is reached in February, we’ll be facing the same painful spending cuts that were postponed this time around. The difference is that instead of a tax hike, the second major consequence for failure will be a default on our debt. The tax hike would have been painful, and it probably would have caused a recession when combined with such steep spending cuts, but the global economy would survive and could have recovered in a year or so.  If we default on the debt, it’s game over. Interest rates will rise, our credit rating will be slashed, and the global financial system that is predicated on the dollar will fall to pieces.

Not only is this new cliff more dangerous, but we’re also more likely to go over it.  A deal would have been much more feasible for Fiscal Cliff 1 than Fiscal Cliff 2. Since current law would have forced a tax increase more than twice what President Obama was looking for, Republicans should have been forced to concede significantly more revenues than they did. This would have given Democrats the justification to cut a big deal that addresses the shortfalls in Social Security and Medicare, in turn giving Republicans the spending cuts needed to accept larger revenue. A grand bargain could have set us on a sustainable fiscal path and given all sides a big win.

That’s not the case with the debt ceiling. Republicans aren’t realistically going to give up any more revenues in Round 2. The justification for this deal was that taxes were automatically going up whether they liked it or not, so the GOP might as well make the increase as small as possible. With the Bush Tax Cuts now permanent, Republicans can’t raise revenues and sell it to their base as a tax cut anymore. And since there were no spending cuts in the fiscal cliff deal, they will be demanding steep cuts in exchange for raising the debt ceiling. But Obama and the Democrats won’t agree to such cuts without even more revenue. This means that both sides will lack the kind of leverage in February that they had this time around. In short, we’ll be hopelessly gridlocked.

But the final thing that makes Fiscal Cliff 2 worse than its predecessor is that it’s not reversible. The deal that Congress passed this week is being framed as an 11th Hour compromise, but it would be more appropriate to call it a 14th Hour one—it passed a full day after we went over the fiscal cliff. The good news is that a single day over the cliff is insignificant; taxes could always be retroactively cut and spending cuts could be delayed. But we have no such breathing room with the debt ceiling. When the treasury runs out of tools at the end of February to pay our creditors, we’ve defaulted and we can’t undo that. There are no 14th hour deals to be made next time around.

President Obama and Speaker Boehner were on track to negotiate a “Grand Bargain” until mid-December.
(Chart by the Washington Post)

So what should have happened instead? Once we went over the cliff, we should have stayed over it until we came to a consensus. As the chart above shows, things were looking pretty good before the “Plan B” debacle. If both sides had stuck to their principles, we could have raised more revenue, cut more spending, and raised the debt ceiling all at once. We could have had a grand bargain. Instead, Congress took the easy way out: they cut taxes and punted all the tough decisions for another two months. And even then, they did it a full day after missing their deadline. This was not a breakthrough for bipartisanship, it was a breakdown of our government–and I predict it will only get worse from here.




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About the author

Ben Ritz

Ben is the former Policy Director and Fiscal Policy Chair for the AU College Democrats. He is currently employed at the Concord Coalition where he is an aggressive advocate for sustainable budget policies. Previously, he has worked at the Economic Policy Institute and offices in all three branches of government.

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