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(Slightly) Beyond the “Fiscal Cliff”

The financial and political papers and blogs are full of the question of whether a deal will be found to avoid the “fiscal cliff” at year end. Many commentators miss the point … the real question is about the first half of 2013.

Let’s make sure that we are on the same page. Wanting to get through the November 6 election, and being unable to resolve big issues, politicians of both parties (the president, the Senate, and the House) agreed to a group of deferrals:

-  They couldn’t agree on taxes, so the Bush tax cuts ($330 billion annually; $42 billion for “the rich”) were extended to this December 31;

-  They couldn’t agree on a budget or reductions to the trillion dollar deficits, so a set of very painful automatic cuts (about $55 billion in defense and $75 billion in other discretionary, annually) were set to kick in on January 1;

-  The  two-year reduction of Social Security taxes, limiting the employee portion of the tax to 4.2 % rather than 6.2 % at a cost of some $200 billion, will expire on December 31;

-  They haven’t been able to minimize deficits, so it will be necessary to increase the debt ceiling (now $16.4 trillion) around the end of the year.

As to the cliff at the end of the year, there is some reason to be concerned that the hotter heads might prevail, as they did during the first effort to pass the Troubled Asset Relief Program (TARP) back in 2008 when the stock market went down 7% in a day before the Republicans relented, or during the argument over increasing the debt ceiling in 2011 which led to S&P downgrading US debt. With President Obama and Speaker Boehner making accomodating noises, the consensus is that a deal will be found and happy times will be here again.

Not! The symptoms may be masked, but the disease rages on.

Nothing has changed about the reality that we continue to run trillion dollar deficits, Social Security and Medicare remain on the short road to bankruptcy, the corporate and individual tax codes are riddled with inefficient favoritisms, and government policies (Obamacare; EPA; Dodd-Frank; etc.) continue to hold back the economy. No year end deal will solve any of these problems.

So, what really will happen?

1. There will be a very limited deal to push solutions into 2013.

-  Obama will want to raise taxes on the rich as part of a deal to kick the problem into 2013 – his successful mantra from the campaign, and just about his only coherent thought on matters financial. Boehner will probably give him a reduction in exemptions on high wage earners (and maybe a rate increase if Obama demands symbolism) and will want a commitment to address entitlements along with comprehensive tax reform and spending cuts in the first half of the year. If the past is prologue, Boehner will give something in exchange for a promise.

-  There will be an agreement that nobody wants the sequestration plan for automatic cuts to defense and discretionary programs to take effect. Both sides will agree to push that into next year, perhaps with a fig leaf of minor Democratic concessions in exchange for some defense cuts.

-  The consensus is the Social Security taxes will go back up - after all, the program is going broke, the recession officially ended in 2009, and AARP wants to protect the seniors.

2. The Republicans will make careful use of their hammer, the debt ceiling limit - which will be breached in December, but can be extended into 2013 by creative accounting.  Treasury Secretary Geithner is whimsically recommending that the concept of a limit be eliminated; the Republicans will probably re-set it for a mid-year clash at about $17 trillion to force action on debt-reduction negotiations.

3. Paul Ryan will be the center of negotiation for a “Grand Bargain” on taxes, spending, and entitlement programs. Beyond taxing the rich, Obama doesn’t seem much interested; Geithner will probably be moving on; and spending bills are supposed to originate in the House anyway. (Note that full acquiescence to Obama’s “tax the rich” strategy would close less than 10% of the budget gap, even assuming that it didn’t hurt the economy. Much, much more is needed.) Look for something resembling Bowles-Simpson with cuts far exceeding taxes, particularly if Erskine Bowles were chosen to replace Geithner.

There is a relatively narrow window of opportunity before the next political cycle.  If House Republicans don’t force action by late 2013, the chances for anything approaching financial solvency approach nil. In any case they will get the blame, they might as well do it right.

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This week’s video is the real story of General Petreus’ resignation.

www.RightinSanFrancisco.com

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