Greg Ip

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

The Senate tax bill: A dreadful third option

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Dec 14th 2012, 19:54 by G.I. | WASHINGTON, D.C.

Negotiations over the fiscal cliff appear to have stalled. A meeting last night between President Barack Obama and John Boehner, the Republican speaker of the House of Representatives, produced no apparent narrowing in their positions.Since negotiations began, very little progress has been made: Mr Obama initially asked for $1.6 trillion in tax increases over the coming decade, later lowered to $1.4 trillion, and offered $400 billion in spending cuts.

Mr Boehner has, in return, offered $800 billion in higher revenue by eliminating tax expenditures (i.e., no increase in rates), and asking for $600 billion in entitlement cuts. Both sides say they are waiting for the other to specify details of their demands, in particular on spending. Mr Boehner is apparently headed home to his Ohio district for the weekend, a sign that no progress is being made.

Until this point there have been two likely outcomes: no deal at all and the country going over the cliff, or a grand bargain. But there is third option. Mr Obama has been demanding the House pass an-already passed Senate bill (S.3412) that keeps tax rates where they are for families making less than $250,000 and lets the others return to their pre-2001 level. There is growing support among Republicans for this option, and indeed Andy Laperriere, policy analyst for ISI Group, now considers it the most likely outcome. Neither the world, nor the stock market, appreciates how bad this would be. Mr Laperriere explains:

First, since Congress won’t deal with most of the items that contribute to the fiscal cliff, the initial fiscal tightening in 2013 will be about $426 billion at an annual rate, far larger than investors have been expecting. Second, this is an acrimonious outcome that portends more budget fights next year. Third, the debt ceiling increase is just around the corner (late February to early March), so when Congress returns next year investors will be facing another potentially destabilizing budget-related deadline.

To put that in perspective, $426 billion per year is 2.7% of GDP, and because most of that tightening will occur in the first half of the year, the impact on annualized growth in the first two quarters will be greater, easily enough to push growth into negative territory. In other words, this third option is enough to produce a recession.

Howard Gleckman at the Tax Policy Center’s TaxVox blog breaks it down into more manageable numbers:

Relative to current policy (where most of the 2001-2010 tax cuts are extended) … the average tax increase would be about $1,200 in 2013. [M]illionaires would pay … about $136,000 more … Those making between $100,000 and $200,000 would pay about $2,500 more…[That] does not reflect higher payroll taxes that would be withheld from most paychecks if the Congress adopts last summer’s Senate bill. On average, this will cost a worker about $700 next year.


Not only would the Senate bill allow a substantial hit to the economy, it would not lance the boil of political dysfunction that has brought America to this point. The bill extends the middle-class tax cuts for only one year, meaning another fight would loom no more than a year from now. It does not move the sequester, it does not restore some of the expiring stimulus, and it does not repeal a big cut to scheduled Medicare reimbursement rates for doctors. Mr Laperriere notes that, eventually, some sort of deal would likey be struck to retroactively fix these problems, but there is no guarantee of that. And what would be the effect of going down this fiscal slope, as opposed to cliff? Ben Bernanke was asked that question earlier this week. Although he was speaking of going briefly over the full cliff, the analysis is mostly valid for this third option as well: 

I don’t buy the idea that a short-term  descent off the fiscal cliff would be not costly. I think it would be costly and, in fact, we’re already seeing costs. Why is it that consumer confidence drops so sharply this week? Why is it  that small business confidence drop so sharply? Why are the markets volatile? Why is business investment among its weakest levels, during the recovery? I think all of these things, at  least to some extent, can be traced to the anticipation and the concern about the fiscal cliff. We don’t know exactly what would happen but I think there is certainly a  risk that it could be serious.

Of course, House passage (or planned passage) of S.3412 and nothing else may serve mostly as a negotiating tactic to force a grand bargain. Keith Hennessey, a former Bush Administration official, writes:

I hope this scenario does not occur, and I do not want to see S.3412 enacted into law, but having it as a viable legislative fallback helps the negotiating dynamic with the President. There is no reason why Republicans should feel pressured to accept any offer from President Obama that they deem to be worse than this bill… [It] is important to understand that, even if you are unwilling to challenge President Obama’s bluff, Republicans have a third option, a legislative alternative to an Obama-Boehner deal.  And that gives them and their negotiator at least a little bit of leverage.

If we make it into next week with no progress on the cliff, Mr Boehner may signal a willingness to let the Senate bill to come to a vote, presumably to pass with mostly Democratic votes. (Because money bills must originate in the House, an identical version of the bill would have to be introduced and then, upon passage, sent to the Senate). The stock market would then sit up and take notice. Again, here’s Mr Bernanke:

If you look at … a very informative experience of the debt limit debate in August of 2011, both confidence and markets remain pretty sanguine, up to pretty close to the point where it looked like there was actually a chance the debt limit would not be raised. And then, of course, there was a pretty sharp shock, particularly to confidence.

Asked if it markets will have to tank for the politicians to do a deal, he said, “Well, I certainly hope that markets won’t have to tank.” Keep hoping.

The original post is linked here.


Written by gregip

December 14, 2012 at 4:34 pm

Posted in Blog posts, Taxes

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