Fiscal Cliff—The Well Orchestrated Dance
As the Democrats and Republicans continued their political theater this past week, coming closer step by step to an agreement on the so-called Fiscal Cliff (aka ‘Austerity American Style’), it has become increasingly clear that the key to a final agreement is how much and how to raise taxes. Given the offers and latest positions of Obama-Boehner in recent days, both are one, possibly two, steps at most away from a final agreement in principle on the tax issue. And once the tax side of the fiscal cliff debate is resolved, the spending cuts issue will quickly fall into place.
Since November 2010 and the publication of the Simpson-Bowles report, both sides have been always in agreement on the target of $4 trillion in deficit cuts. The contention has always been how much tax increases vs. how much spending cuts. Within the tax side of the equation, how much will the wealthiest 2% pay vs. how much the middle class will have to pay in a ‘broadened tax base’; while on the spending side, how much to cut military spending vs. how much to cut social programs, and social security-medicare-medicaid, in particular.
Since the Simpson-Bowles issued two years ago there has always been agreement in principle on a target of around $4 trillion in deficit reduction. That number was confirmed in Obama’s budgets of the past two years, in Paul Ryan’s House budget proposals, in the aborted ‘grand bargain’ in the summer of 2011 between Boehner and Obama, and is the target once again, in the abrupt return to deficit cutting after the hiatus from deficit cutting during the 2012 election year.
In a well orchestrated political dance, yesterday, Monday, December 17, Obama took the lead in the fiscal waltz and agreed to reduce the tax revenue mix a second time. After an initial offer of $1.6 trillion in tax revenue generation (tax hikes) two weeks ago, he reduced it to $1.4 trillion last week, and again, most recently, to $1.2 trillion. Boehner raised his offers for tax revenue, from an initial $800 billion to $1 trillion. A compromise at $1.1 trillion is just about what Simpson-Bowles recommended two years ago.
Boehner has also agreed in principle to some kind of increase in the top tax rate, while Obama has signaled he’s willing to give up on his $250,000 threshold, suggesting $400,000, but indicating even this was not his last offer. Boehner offered $1 million. It’s not unlikely they’ll settle at around $600,000, which is approximately the average annual income of the wealthiest 1% households in the US.
So the parties, Boehner and Obama, are virtually agreed on the tax question. The only issue is how much tax revenue will be realized from tax rate increases vs. tax bracket manipulation. With just one or two offers from an understanding on the tax issue, the parties are already moving on to determining how much spending cuts will accompany the revenue hikes. If the final deficit reduction target is $4-$4.4 trillion over the coming decade, that means another roughly $3 trillion in spending cuts and/or tax hikes on the middle class will be necessary.
Evidence that Obama and the Democrats are about to make a significant offer in spending cuts is indicated by Obama’s meeting yesterday with Democratic House leader, Nancy Pelosi. They’re getting ready to up the ante in cuts in social programs in the next move or two. Since last week the parties’ respective positions, Republican and Democrat, spending cuts was an offer of $340 billion in Medicare-Medicaid cuts by Obama and a $600 billion proposal by Boehner. Watch for around $500 billion in Medicare spending reduction in a final deal—although not in the form of benefits cuts but in hikes in Part B and Part D deductibles and copays by retirees. So that’s a total of about $1.5 trillion in revenue from the wealthiest 1% plus Medicare over the coming decade.
Forget about the $500 billion in defense cuts called for in the sequestration deal of August 2011. That’s no longer an issue, and never was. If readers had listened closely to Obama in the second presidential debate, when asked by the moderator what was his position on that issue, he briefly answered ‘that was Congress’ proposal, not mine’. The Congressional Budget Office estimates that even in the sequestration deal, only $24 billion in 2013 is scheduled in defense cuts. Look therefore for about half, or no more than $200 billion over ten years in military spending cuts. That will come from withdrawal from Afghanistan and Iraq and Army personnel downsizing. Military equipment expenditures will likely actually rise, however, after 2014 as the US military redeploys to the western pacific and Navy-Air Force spending takes precedence over Army expenditures. Defense equipment companies know the deal for them is already cut. They reportedly even have no ‘Plan B’, according to the Wall St. Journal, in the event that military spending is reduced per the sequestration agreement, which is now virtually out of the question. Unlike the reduction of the cuts in military spending by half in a Fiscal Cliff agreement, don’t expect the other $500 billion in the 2011 sequestered cuts social programs to be similarly reduced by half.
Adding up the likely amounts in a final Fiscal Cliff deal, there’s the $1 trillion in tax revenue generation, the $500 billion Medicare spending cuts, about $250 billion estimate in military spending reduction (mostly by attrition), and the roughly $500 billion in Education and other cuts scheduled since August 2011. The leaves $1.5-$2 trillion more in tax hikes and spending cuts to achieve the $4 trillion target.
That remaining amount will likely come from a ‘broadening the tax base’—i.e. the code word for cutting tax deductions, credits, exemptions, etc., now enjoyed by the middle class. That means those with annual family incomes ranging from $118,000 to the $400,000 recently offered by Obama. Expect limits on their mortgage deductions, state-local tax deductions, charitable and medical insurance deductions, education credits, etc. over the coming decade. If around $50 billion a year, ‘broadening the tax base’ will produce another $500 billion over the coming decade. Elimination of the 2% payroll tax cut will mean another $900 billion to a $1 trillion over the coming decade.
We’re now at a total of about $3.75 trillion in deficit reduction, and just a step away from the $4 trillion target. Apart from savings from interest on the federal debt as a result of the deficit reduction, and assumed tax revenue from economic recovery (which may not happen), the rest could easily come from social security, in the form of reducing the cost of living formula adjustments, raising the retirement age toward the end of the ten years, and reducing social security disability eligibility—all of which are proposals of the Republicans. If House Democrats won’t agree to the social security cuts, then additional cuts in Medicaid at about $10-20 billion a year closes much of the remaining $250 billion gap. And there’s the $4 trillion.
What we’re witnessing this past week, and the week to come, are the chief negotiators (Obama and Boehner) going through the motions publicly to appear as if they’re driving a hard bargain, in order to placate their respective bases in Congress. However, the deal is already done in principle. The dance is for the audience.
Four weeks ago, immediately following the November 6 elections, this writer publicly predicted a deal would happen. That was because major corporate CEOs were now aligning strongly behind Obama. Their joint pressure, it was predicted, would result in splitting the Republican ranks, with the Republican Senate and major corporate campaign donors putting pressure on the House radicals. All that was needed was a switch in 25 votes in the House to seal a deal. A threat of withholding future corporate campaign donations would likely sufficient to buy 25 votes in the House on the Republican side, it was argued. Obama has been meeting the past two weeks with groups of Corporate CEOs at minimum twice and three times a week. Key CEOs have been playing lobbying middlemen between the White House and the Congress—and especially the House of Representatives—now for several weeks. This Corporate CEO factor and direct involvement is a new element in the equation absent in 2011 deficit debates and reductions.
So why are Corporate CEOs so aligned with Obama this time around? Because a deficit reduction deal is a prerequisite for what they really want—a cut in the corporate tax rate, understandings on non-enforcement of the foreign profits tax, and further incentives—all of which Obama (and Romney) promised in the recent elections. Obama is on record during the elections, and well before, in favor of cutting the top corporate tax rate from 35% to 28%--i.e. where it was during the Reagan period. The idea, in other words, is to raise the rate on the personal income tax a couple percent, and later cut the corporate rate by 7% in the summer 2013 as part of a major revision of the tax code.
But major corporate tax cuts cannot happen in the current negotiations. It would look as if medicare-social security were being cut, and middle class taxes raised, in order to fund big corporate tax cuts. Moreover, cutting the corporate tax rate to 28% cannot be part of the current negotiations and still get the $4 trillion in total deficit reduction. So the corporate tax cuts will come in a subsequent phase later in 2013. And when that second phase happens, one can expect another round of cuts in Medicare and Social Security as part of that subsequent deal as well.
Whether taking place in phase one, between now and March 27, or in a subsequent phase two, in the coming Fiscal Cliff deal both the revenue hikes and spending cuts will be mostly ‘backloaded’. They will not take full effect in 2013 or even equally across the decade. Most will begin to have their greatest impact in 2014 or even in 2015 and beyond.
In terms of time lines, January 1 is not the real deadline date despite all the press hype. Cuts and tax hikes can occur after and made retroactive to January 1, 2013. The real deadline, if any, is March 27, 2013. That’s when the federal government runs out of money. A deal could be reached in key principles, if not in detail, before January 1 and more formally concluded after January 1. However, it will then be followed by a second phase deal later in 2013 in the form of a major tax code revision, which will include further spending cuts.
So sit back and watch Boehner and Obama stumble around the dance floor for another week. Most of the main elements of an agreement are already in place. Negotiations between Boehner and Obama are not the real problem. Not even Congress. The Senate has already agreed and is waiting in the wings to sign off on a deal quickly. Even Senate radicals like Coburn and Corker are fully on board.
Getting the Teapublicans in the House to buy entitlement cuts in exchange for token tax hikes on the wealthy, and getting Pelosi to corral liberal Democrats in the House to agree to Medicare-Medicaid-Social Security cuts are the real remaining negotiations.
The glue is CEOs promising some big election contributions in 2014—or the withdrawal of the same—or the withdrawal of the same. And it probably won’t take much to buy the necessary votes—from either side of the aisle in the House.
Jack Rasmus is the author of book “Obama’s Economy: Recovery for the Few”, 2012, and host of the weekly radio show, ‘Alternative Visions’, on the progressive radio network, PRN.FM. His website is www.kyklosproductions.com, his blog, jackrasmus.com, and twitter handle #drjackrasmus.