Sunday, December 9, 2012

Fiscal Cliff Gamble

The Obama Administration and House Republicans remain deadlocked in budget negotiations. At issue is the extent to which the Bush tax cuts will be retained. Obama wants to extend them for those making under $250,000 a year. Republicans want to extend them for everyone.

It is puzzling why the Bush tax cut, enacted as a temporary measure, have evolved into a sacred cow to Republicans. The cuts are just one more bit of residue left by the fiscally irresponsible Bush administration. Republicans claim that the increase in taxes will harm the already weak economy. Sometimes Republicans appear to oppose tax increases for any reason.

In addition, the Republicans see the tax policy as the only leverage they have to reduce spending. So far, however, they have been unable to leverage anything. The Social Democrats already have ruled out any cuts in so-called entitlements, the largest threat to fiscal solvency. In an earlier post, I suggested granting the President his wishes, perhaps by voting "present" on tax provisions. Then they can fight on the spending side of the government ledger. If they fail to secure significant reductions in spending, perhaps they can rally around the "debt ceiling" fight that will come in January. That will not really reduce existing the amount of money budgeted for specific programs, but it will stop to government from borrowing to fund those programs. Perhaps this will force the government to prioritize its spending and reduce it. 

Another option is to call the administration in its threat to go over the so-called "fiscal cliff.."

"Going over the fiscal cliff" simply means implementing the provisions of the Budget Control Act of 2011. This will force both severe spending cuts and steep tax increases. This entails some high stakes risks.

First, no one is certain what this will do to the economy. On the one hand, conservatives claim that government spending, especially that contained in the various "stimulus packages," does not create jobs. If this claim is true, then cutting government spending through sequestration should not adversely impact the economy. On the other hand, Republicans claim tax increases will hurt the economy. The question is if either reduced spending or increased taxation--or both--will send us into a recession.

Second, the political fallout must be considered. On the one hand, the last thing Obama wants is a recession in his second term. His first term proved pretty pathetic, but voters decided to give him more time. A recession would consign his presidency to that large class of Presidential mediocrities. On the other hand, polls show by a 53-27 margins that Republicans would carry the blame for failure to close a deal with the President. That might portend trouble for 2014.

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