Fiscal Cliff

12.31.12

Washington May Have a Deal on Taxes, but the Toughest Problems Remain

The Senate voted to raise taxes on the richest Americans, but Congress and the President avoided the tough calls on entitlements and defense. Given the players’ intransigence, particularly on the right, what else did you expect? By Daniel Gross.

This is not the cliff we’ve been waiting for. When we first began charting the Fiscal Cliff Hostage Situation on the day after the presidential election, many observers scoffed. Surely, after a clarifying election, Democrats and Republicans would come together quickly to hammer out a deal to avoid the sunset of the Bush-era tax cuts and the jerry-rigged spending guillotine known as the sequester. But those of us who have been sentient for the last several years, who lived through the horror of the TARP votes, whose August 2011 vacations were ruined by the debt-ceiling debacle, knew otherwise. After all, true believers tend not to compromise on matters of theology. And the first commandment of the modern GOP reads: “Thou Shalt Not Vote to Raise Taxes.”

Against all odds, the Senate voted on a compromise—if only on the issue of taxes. As the remaining hours of 2012 ticked away, Senate Majority Leader Mitch McConnell and Vice President Joe Biden ironed out a deal. “I can report that we’ve reached an agreement on all the tax issues,” McConnell said in the early evening, as the deal came to predawn vote on Tuesday. Income tax rates would be preserved for families making less than $450,000, rather than the $250,000 that the president wanted. (This upward redefinition of rich from $250,000 to $450,000 will henceforth be known as “The Miracle of Fairfield County.”) Extra unemployment benefits would be extended for another year. As for spending, entitlements, the sequester, and the debt ceiling? Like a long-feuding, long-married coupled, the two parties agreed to go to sleep and argue about it in the morning.

The reactions were entirely predictable. The stock market, which fears short-term austerity far more than it fears large deficits, or partisan warfare, rallied on the news of a near-agreement.

^SPX Chart

^SPX data by YCharts

Liberal Democrats, concerned that President Obama once again had sold them out for a half-measure compromise with Republicans, frowned. “No deal is better than a bad deal, and this looks like a very bad deal, the way this is shaking up,” said Iowa Sen. Tom Harkin. President Obama held a strangely off-key press event, at which he gloated that the as-yet-unsigned deal would force Republicans to vote for higher taxes and threatened to shove things into unnamed orifices of his opponents. As it dawned on Republicans that they might actually be casting affirmative votes on a measure that the president approved, they became cranky. Oh, and after the stock market closed, the House GOP threatened to derail the whole thing, announcing it hadn’t yet scheduled a vote on a potential deal.

So long as the contours of the deal hold, it almost doesn’t matter whether we actually go over the cliff. Congress can simply reconvene after the New Year and pass the relevant legislation.

Virtually all parties in Washington are able to spin a tale of victory to their base supporters from this deal. Democrats will be able to claim that they finally got Republicans to vote for higher taxes and sign off on unemployment benefits. Republicans will be able to claim that they got Democrats to make virtually all the Bush-era tax cuts permanent without giving up leverage on the debt ceiling.

But there is one set of Washington players for whom the fiscal-cliff drama was something of a disaster: budget deficit hawks. The fiscal-cliff drama will likely end without any grand bargain on revenues and entitlements. Yes, adjusting some of the Bush tax cuts will bring in some more cash. But on Social Security, Medicare, tax loopholes? Nothing. What’s more, the last several weeks have demonstrated the political impotence of some very powerful and moneyed players. Well-funded groups like Fix the Debt and the Committee for a Responsible Budget enlisted CEOs and other worthies behind the cause of a grand bargain. Starbuck’s urged caffeine fiends to “come together.” Blackstone Group co-founder Pete Peterson has spent hundreds of millions of dollars on conferences, campaigns, advertisements, and advocacy in favor of a grand bargain. And yet week after week, month after month, year after year, the system ignores their pleas.

Should the deal ultimately come through, virtually all parties in Washington will be able to spin a tale of victory to their base supporters.

And it has done so for two reasons that the professional deficit scolds should understand: (1) politics and (2) markets.

Simply put, there is no political climate or constituency for a grand bargain. The fault lies overwhelmingly (although not entirely) with Republicans. A grand bargain would involve agreeing to raise tax revenues through boosting rates or loopholes while cutting entitlement and defense spending. But Republicans generally don’t believe in raising tax revenues (they’re never willing to name the loopholes they’d close), don’t want to cut entitlements for those who now receive them, and don’t want to cut defense spending. Democrats believe in raising tax revenues, but don’t want to cut entitlement for current and future recipients, and are ambivalent about defense cuts. Do you see the political common ground for a deal there? Me neither.

Meanwhile, the markets have steadfastly refused to cooperate. Deficit scolds have always said that the U.S. could become the next Greece if it fails to close its deficits. But in the last several years, as deficits have exploded, America’s borrowing costs have plummeted. Meanwhile, in contrast to Greece, the U.S. private sector has thrived in recent years. Profits have soared to historic levels, and the stock market has doubled since March 2009. Looking solely at the charts of the stock and bond markets over the last few years, you’d never guess America has a woeful fiscal situation.