The Fiscal Cliff Discussion: Part II What it Portends for the Years Ahead

Let’s revisit the so‑called fiscal cliff negotiations about which we wrote last week.  Finally in this past week, the president met with Speaker Boehner; a meeting the Speaker has been pursuing and the president has been ducking.  Perhaps a deal will be reached.  But let’s understand that President Obama’s strategy in this fiscal cliff negotiation has nothing to do with economics or with real fiscal reform.  As Charles Krauthammer puts it, “It’s Phase 2 of the 2012 campaign.  The election returned him to office.  The fiscal cliff negotiations are designed to break the Republican opposition and grant him complete political supremacy, that he thinks he earned with his landslide 2.8‑point victory margin on Election Day.”

John Boehner would like nothing more than to compromise although he has to worry about his own caucus.  As columnist Michael Gerson put it, “Boehner needs to tell the President: I can give some on rates for the wealthy but I need cover on serious, structural cuts in entitlement programs.”  The President, however, has refused to layout on the table what it is that he is prepared to cut.  It can’t be “rates only and we will have a serious conversation next year after I have pocketed the revenue from the rate increases.”  Already Republicans have proposed raising as much revenue as the President originally sought  by denying deductions, as we have discussed, but Obama is fixated on rate increases.

There is something in this for the President.  Since the election, President Obama has focused the fiscal-cliff debate solely on taxes, but, sooner or later, he has to consider his presidency in a much broader context.   The president will have a legacy and one wonders whether he wants to spend his entire second term facing opposition over every spending program, and every possible nuance in the budget, simply because of his apparent determination completely to eviscerate the Republican Party.  Federal spending has traditionally been about 18 to 19 percent of the U.S. economy and is now at 23 to 24 percent.  Candidate Romney proposed a 20 percent limit.  The Simpson-Bowles Deficit Commission, which the president walked away from, called for 21 percent.  Negotiators need to agree on a ceiling or there will be no incentives for elected and administration officials to discipline the inevitable rise in spending.

As Robert Zoellick put it, “President Obama seems to be pushing two options.  One is to achieve spending “savings” by double counting a trillion dollars over 10 years that has been already “cut,” “returning” almost a trillion dollars the United States will not spend on wars, and then adding a large tax increase, supposed interest savings, and some token program cuts.

The president faces, quite frankly, a risk of overwhelming his health care program by its own costs if it does not align incentives on use with its purpose of expanding coverage.  Again as Mr. Zoellick points out, “The Catastrophic Health Care program passed in the Reagan administration had to be repealed once citizens could see the increased costs charged transparently on tax returns.”  The CBO, probably the only agency with any credibility on projections states:

“The budget outlook is much bleaker under the extended alternative fiscal scenario, which maintains what some analysts might consider “current policies,” as opposed to current laws. Federal (public) debt would grow rapidly from its already high level, exceeding 90 percent of GDP in 2022. After that, the growing imbalance between revenues and spending, combined with spiraling interest payments, would swiftly push debt to higher and higher levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2026, and it would approach 200 percent in 2037.

The changes under this scenario would result in much lower revenues than would occur under the extended baseline scenario because almost all expiring tax provisions are assumed to be extended through 2022 (with the exception of the current reduction in the payroll tax rate for Social Security). After 2022, revenues under this scenario are assumed to remain at their 2022 level of 18.5 percent of GDP, just above the average of the past 40 years.

Outlays would be much higher than under the other scenario . This scenario  incorporates assumptions that through 2022, lawmakers will act to prevent Medicare’s payment rates for physicians from declining; that after 2022, lawmakers will not allow various restraints on the growth of Medicare costs and health insurance subsidies to exert their full effect; and that the automatic reductions in spending required by the Budget Control Act of 2011 will not occur (although the original caps on discretionary appropriations in that law are assumed to remain in place). Finally, under this scenario, federal spending as a percentage of GDP for activities other than Social Security, the major health care programs, and interest payments is assumed to return to its average level during the past two decades, rather than fall significantly below that level, as it does under the extended baseline scenario.”

As The Wall Street Journal points out, Republicans absolutely need to stop negotiating with themselves.  If any of them thought that the president would respond with magnanimity in victory they now know better.  He is determined to rout them on taxes, give as little as possible on spending and then blame them for the economic damage in the bargain.

If all of this ends unsuccessfully let’s just take a quick look of what happens with regard to taxes.

• The capital-gains tax rate increases from 15% to 20%, while the 15% dividend tax rate increases to the income tax rate (essentially tripling for those families earning over $250,000).
• The Department of Defense reduces its budget by 10%.
• Discretionary programs, including education, law enforcement, low-income energy subsidies, roads, and homeland security, will see an 8% cut in budgets.
• Unemployment benefits will revert back to a 26-week limit from the 99-week limit.
• The child tax deduction of $1,000 is reduced to $500.
• A $2,500 tax credit for school expenditures per year for four years falls back to a $1,800 credit per year for two years.
• The payroll tax holiday that saves 2% on Social Security taxes on the first $110,000 in wages will end.
• The estate tax changes from a $5 million exemption and a 35% tax rate to a $1 million exemption and a 55% tax rate.
• Medicare provider payments drop by 2%.

Curiously, as William McGurn writes in The Wall Street Journal, Mr. Obama admits that he got the Bush tax cuts all wrong, but he doesn’t say it that way.

Here’s how President Obama put it during a recent White House event with a group of middle‑class Americans:  Unless Congress acts, he said, ‘starting Jan. 1, every family in America will see their taxes automatically go up.’

He went on:  ‘A typical middle‑class family of four would see its income taxes go up by $2,200.  That’s $2,200 out of people’s pockets.  That means less money for buying groceries, less money for filling prescriptions, less money for buying diapers.  It means a tougher choice between paying the rent and paying tuition.  And middle‑class families just can’t afford that now.’

To emphasize that these cuts are a big deal, he asked people to ‘tell members of Congress what a $2,000 tax hike would mean to you.”  He is now taking his message on the road, telling a group of Michigan autoworkers last Monday that the end of the Bush cut would be ‘a hit you cannot afford to take.’

For most of the past ten years, Democrats have been hollering that the only people to benefit from the Bush tax cuts were Bill Gates, Wall Street bankers, and the guy with the top hat and monocle who appears on our Monopoly sets.  Now the same press that accepted, approved and amplified the ‘Bush tax cuts for the wealthy’ trope leaves unchallenged a president who today tells us, oh, by the way, those Bush tax cuts are vital for America’s middle class‑‑and claims that the opposition to middle‑class tax cuts proposed and put into law mainly by Republicans comes from . . . Republicans.

Whether or not a deal is made in the current negotiations, it is going to be a long four years of bullying by President Obama, and the people and the economy are destined to be the victims.