Greg Ip

Articles by The Economist’s U.S. Economics Editor

The Fiscal Cliff deal: Nothing to be proud of

leave a comment »

Barack Obama wrings an 11th-hour deal on taxes from John Boehner and the Republicans, but accomplishes little else

Jan 5th 2013 | WASHINGTON, DC | from the print edition

[Greg Ip] THE deal to avert the fiscal cliff had not yet been sealed when Barack Obama allowed himself to gloat a little. “Last month, Republicans in Congress said they would never agree to raise tax rates on the wealthiest Americans,” he reminded a friendly White House audience on December 31st. Yet the deal would do just that, he declared. And they all applauded him.

The tax deal enacted this week, which leaves income-tax rates where they are for 99% of households while raising them sharply on the top 1%, was indeed a political victory for Mr Obama. For the first time in more than two decades Republicans had voted for higher taxes, by large numbers in both the Senate and the House of Representatives. The deal raised almost as much money from the rich as Mr Obama had first sought, and he made no meaningful concessions on spending in return.

It was less of a victory for the economy. It leaves in place significant short-term fiscal tightening, while doing almost nothing to arrest the escalating national debt in the long term. Mr Obama himself conceded that at the White House: “We still have deficits that have to be dealt with,” he said, surely his understatement of the year.

Nor did the deal spell relief from the political polarisation and brinkmanship that produced the fiscal cliff, a collection of tax increases and spending cuts all scheduled for the start of 2013. It delayed the “sequester” (across-the-board automatic spending cuts) for just two months. It did not raise the legal debt ceiling. Without such an increase, in about two months the Treasury will have to suspend new bond issues and stop paying some bills.

“Instead of clearly demonstrating to American businesses…that we can still govern…we leave them saying, ‘Not again’,” complained Tom Carper, a Democrat and one of the few senators to vote against the deal. “Two months from now, we face the prospect of yet another debt-ceiling crisis and more turmoil.” Steve LaTourette, a Republican congressman, called the result “disgusting…It’s not even small ball—it’s a ping-pong ball,” produced by “sleep-deprived octogenarians on New Year’s Eve”.
The deal has some redeeming features. Besides avoiding tax increases worth more than $200 billion a year, it restores stability to the tax code, though perhaps not for long, since it still generates too little revenue. The lower tax rates first enacted by George Bush in 2001 and 2003, which expired on December 31st, are reinstated and made permanent for everyone except individuals earning more than $400,000 and couples earning more than $450,000. Their rate will rise from 35% to 39.6%, the level it was at before 2001. Individuals earning $250,000 or more will lose some tax deductions. Rates on capital gains and dividends will rise from 15% to 20%, still lower than their pre-2001 level. The deal raises estate taxes, but they remain below pre-2001 levels. Expansions to tax credits for families, workers and college students enacted by Mr Obama in 2009 will remain in place for five more years. The alternative minimum tax, a supplemental tax for the wealthy, has been permanently fixed to avoid ensnaring ever more middle-class families each year.

As expected, the deal allowed a two-percentage point payroll-tax cut to expire. That will reduce the purchasing power of workers by $115 billion, or roughly $1,000 per working household. Combined with higher taxes on the rich and previously agreed federal spending cuts, federal fiscal tightening will, economists think, amount to 1-1.5% of GDP in 2013, with most of that contraction felt in the first half of the year.

That does not seem to faze investors, who responded by sending stocks sharply higher as news of the deal emerged. A more robust housing recovery, a less crisis-prone Europe and steady employment growth may be enough to sustain economic growth near 2% or better in the face of that drag and continued political wrangling. That, of course, assumes that the sequester is eventually moved and the debt ceiling raised—and that the government does not shut down when routine funding expires in March.

The deal cuts $737 billion from deficits over the coming decade, primarily through $618 billion of higher taxes on the rich and the resulting interest savings. But that barely dents the $10 trillion in deficits America was on track to accumulate in that time, roughly 5% of GDP on current policies, according to the Congressional Budget Office. The Committee for a Responsible Federal Budget, an independent watchdog, reckons it would take tax increases and spending cuts totalling $2.65 trillion-3.9 trillion to stabilise the debt near its current ratio, 74% of GDP, by 2022. Even that understates the true challenge, since entitlement costs (health-care payments and pensions) will drive spending ever higher after 2022.

Hopes ran high just eight weeks ago for a better result. Voters returned both Mr Obama and John Boehner, the Republican Speaker of the House, to power on November 6th, and both immediately declared their intention to pursue a grand bargain that reformed taxes and entitlements. Mr Boehner hoped to revive a deal, briefly entertained by him and Mr Obama in the summer of 2011, that would have raised $800 billion in revenue over ten years in return for slowing the growth of Social Security and Medicare benefits. But Mr Obama, his hand strengthened both by re-election and by the economy’s stronger footing, made it clear that his price had risen: Mr Boehner would have to offer more revenue and accept less spending restraint than in 2011. At the same time the president launched an aggressive campaign to ensure that if the country went over the cliff, the Republicans in Congress would be blamed for protecting the rich from higher tax rates.

Mr Obama’s hardball tactics made a grand bargain hard enough; Mr Boehner’s tenuous hold over his own caucus made it all but impossible. He persuaded his caucus to accept higher tax revenue (though not tax rates) in return for entitlement reform, then asked Mr Obama to spell out what those reforms should be, perhaps hoping that the elderly would not hold Republicans responsible. In the week before Christmas, when the two sides were drawing closer, Mr Boehner broke away to press his own bill that raised taxes on millionaires only. He hoped to use it as leverage to squeeze more concessions out of Mr Obama; instead, humiliatingly, he had to withdraw it for lack of support in his own ranks. It was left to two secondary players to craft the smaller tax deal: Mitch McConnell, the Republican minority leader in the Senate, and Joe Biden, the vice-president and a former senator.

Mr Obama greeted passage with a renewed promise to work with Republicans to reduce the deficit: “I am very open to compromise,” he said. But recent events suggest that neither he nor Mr Boehner is up to the task. The two sides will resume negotiations with radically different expectations. Republicans want to use the sequester and debt ceiling to force bigger changes to spending and entitlements. “We’ve taken care of the revenue side of this debate,” Mr McConnell declared.

Mr Obama, on the other hand, says he will not negotiate over the debt ceiling, as he did in 2011. Moreover, he regards the new tax increase as mere payback for more than $1 trillion in spending cuts agreed to in 2011. Further deficit reduction will require taxes to go up yet again, he said on December 31st. “If Republicans think that I will finish the job of deficit reduction through spending cuts alone…they’ve got another think coming.”

Mr Obama’s partisan tone may have been for the benefit of his liberal supporters, many of whom fault him for not holding out for more revenue in the latest tax deal. But those same supporters will remind him that his political success, both in the election and now on taxes, gives him little reason to sacrifice entitlements in search of a compromise with Republicans. The next two months may be as fraught as the last two.

The original artice is linked here.

Written by gregip

January 3, 2013 at 8:19 pm

Posted in Uncategorized

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

Join 63 other followers

%d bloggers like this: