The Fiscal Cliff

The election is over. The balance of power has shifted hardly at all. The perpetual war in Washington continues.

On January 1st America will hit the ‘fiscal cliff.’ This term refers to a huge cut in military and entitlement spending coupled with across-the-board tax hikes that will take effect if Congress fails to reach a deficit-reduction agreement. For all the talk of Obama’s supposed hyper-partisanship and the GOP’s calculated obstructionism, neither party has an interest in letting this happen. Both sides will bluff and posture in an effort to secure the best deal for their party, and neither will be entirely happy with the result. Nevertheless, the likelihood is that an unhappy compromise will be reached.

Democrats want to increase revenue by raising taxes and cutting some military and entitlement spending. Republicans want to increase revenue by cutting a lot of entitlement spending and making the Bush Tax Cuts permanent. Both insist that their stance on taxes is non-negotiable, and that they have a mandate from the American people to prove it.

The election results seem fairly unambiguous – the Democrats won by almost every metric. The President ran on the promise to increase taxes and was easily reelected. They increased their majority in the Senate by two seats in a tough cycle. They won the popular vote in the Presidential, Senate and House totals.

The only metric by which the House Republicans can claim a mandate is the only one that matters: they won the majority of House seats. Through a combination of the rural advantage – Republicans tend to control the less populated rural constituencies, Democrats the larger urban ones – and rampant gerrymandering they still command a solid majority despite losing the popular vote. No bill can pass without the votes of at least 20 Republicans, and so far Boehner has been an effective marshal. Each party will have to give up some of the things that are supposedly off the table.

What will the final bill look like? All the noise that has come out of the White House suggests that Obama will not allow the top-rate tax cuts to be extended under any circumstance. Given that 60% of the electorate agrees with him they will very likely expire. Military and entitlement spending will be cut, but to a far lesser extent than they would under the current arrangement. The deficit will drop slightly, and the economy will continue its shaky recovery.

The GOP faces a stark choice – raise taxes on the wealthy or allow the sequestration to go into effect and raise taxes on everybody. Going over the fiscal cliff would slow or stop the current rate of growth and almost certainly put the country back into recession. The deficit would be halved, but at a price that nobody wants to pay.

Despite the anxiety over the short timeframe and the apparent gulf between their positions, the President and House Republicans are likely to find an acceptable middle ground. The consequences of failure to do so are too great for either party to overlook.

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5 thoughts on “The Fiscal Cliff

  1. I agree that both sides will continue to act like the other is a polar opposite enemy and eventually act like adults silently behind close doors. The problem with this of course is it continues to convince people that either party actually has America’s best interest at heart. If you have a spending problem you don’t continue to spend with the best interest of your family at heart. You do it because you either can’t stop, don’t realize you have a problem, or enjoy it.
    I think both parties simply can’t stop because they promise money to their sacred cows and have to deliver. If they don’t, the next election the other party wins and will pay for their sacred cow. For Republicans it’s defense spending that is bigger than the next 13 countries in the world combined (even China). For the Democrats it social programs that I don’t think even FDR had in mind when he stamped the new deal.

    • “I think both parties simply can’t stop because they promise money to their sacred cows and have to deliver.”

      This is an important point, and one that deserves more airtime – for all that the electorate asks for fiscal discipline, the fact of the matter is that it is incompatible with current levels of spending. Either the entitlement programs and military budget are kept as they are and taxes go up, or these things are cut and taxes stay as they are/go down. Although we may disagree on which of these is more desirable, one thing is clear – if America continues spending like this, the deficit will grow and the economy will suffer. Something’s got to give.

      • I explain it like this to people sometimes, which I am sure you already know. Current debt is $16 trillion, current revenue is $3 trillion. So if the median American household makes $50,000 then imagine if they also had $265,000 in credit card debt. That’s where we are as a country right now. I don’t know a single person who would be allowed to spend that much more than they earn.

  2. Good post again – interesting today Krugman has come out to say that Obama shouldn’t change his stance, as the cliff is not like what it has been likened to, in that recession might not come into effect immediately, and so give Obama a few more months – I don’t know why he came out and said that especially today (or yesterday), but the timing suggests that the fiscal cliff issue will occupy Obama’s honeymoon period.

    • Interesting indeed. He’s right – Obama can (and should) use that as a bargaining chip. I think it depends on what the media narrative is. If they blame the GOP, then great, he can turn the thumbscrews. If not, I suspect he’ll compromise before the New Year.

      The Fiscal Cliff will occupy everyone in U.S. politics from now until it is dealt with, and rightly so.

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