Bloomberg News

Democrats See Leverage as U.S. Congress Stares Down Budget Cliff

May 16, 2012

Congressional Democrats say they can prevail in a year-end fiscal showdown with Republicans, so long as President Barack Obama and Democrats hold firm in their insistence on higher taxes for the rich.

The Democrats are emboldened by the president’s stated refusal to renew expiring income tax cuts for top earners, and they welcome a sequence of deadlines that they say will diminish Republicans’ bargaining power. Treasury Secretary Timothy F. Geithner said yesterday that Congress probably won’t need to raise the federal debt ceiling until 2013, allowing a December tax debate to occur without the risk of an imminent default.

Democrats want the so-called fiscal cliff at the end of 2012 to yield a much different result than in 2010, when the tax cuts were last set to expire. Obama, stung by mid-term election losses that cost his party control of the U.S. House of Representatives, acceded to Republican demands to extend all the tax cuts, rather than allowing those for high earners to expire. This year, the president has taken a harder line and won an extension of a payroll tax cut.

“If the president brings the tough approach he had on the payroll tax holiday to this debate, Democrats have a good shot of taking the upper hand,” said Clint Stretch, managing principal of tax policy at Deloitte Tax LLP. “If the White House brings its ‘Let’s all be grownups and find a bipartisan solution’ approach, then Republicans can probably end up with all the tax cuts extended.”

Lame-Duck Session

The Democratic posture on taxes is part of maneuvering by both parties as they develop arguments for the Nov. 6 election and strategies for the so-called lame-duck session afterward. Obama will meet today with congressional leaders of both parties, and House Speaker John Boehner said Republicans plan to press Obama to say how he wants to address the policies expiring at year’s end.

Congressional Republicans and Democrats maintain they should resolve these big-picture fiscal issues now to be responsible stewards of the economy and the government. They simultaneously say they don’t expect to do so until the end of the year.

The hardened positions of the two parties, particularly on taxes, make it possible that 2013 will arrive without congressional action to prevent automatic tax increases and spending cuts set for Jan. 1. Democrats say higher revenue must be part of a deficit-reduction plan. Republicans say the U.S. should rely on spending cuts alone.

Veto Pen

Democrats’ hoped-for leverage on taxes depends on several events turning in their favor and Obama’s willingness to use his veto pen. Obama would have to hold firm on his insistence that he will let the tax cuts for high earners expire, even if he loses political clout in the election and even if that refusal means that all the tax cuts might expire.

Further, for this scenario to play out the way Democrats envision, the tax issues would be resolved before the U.S. reaches the debt ceiling, and the economy would be able to withstand a temporary reduction in demand from the automatic tax-and-spending changes.

“The leverage really shifts to the president the day after the election, because he’s the president on Dec. 31 whether he wins or loses,” said Representative Richard Neal, a Massachusetts Democrat. “It’s all going to depend on his resolve. If he is determined, then in fact we can strengthen our bargaining position.”

Public Support

Don’t count on it, said Representative Tom Reed, a New York Republican, who said Democrats don’t have the public’s support for higher taxes.

“They’re just trying to cover increased spending,” Reed said. “That fundamental philosophy has to change, and I think the American people will in November hear that difference between us and them.”

If Congress doesn’t act, the income tax rate cuts enacted in 2001 and 2003 will expire and $1.2 trillion of spending reductions over 10 years established in the 2011 debt-limit agreement will take effect. A 2 percentage-point payroll tax cut will expire and the government will near the debt limit again.

Ben S. Bernanke, the chairman of the Federal Reserve, has warned of the potential economic effects of falling off the fiscal cliff. The combination of those policies would reduce the gross domestic product by about 3 percent, according to Barclays Capital.

‘Significant Risk’

“I am concerned that if all the tax increases and spending cuts that are associated with the current law and which would take place absent any congressional action were to occur on Jan. 1 that that would be a significant risk to the recovery,” Bernanke said April 25.

Still, the economic effects would be limited, especially if they are temporary and provide a shock to force Congress into action, said Robert Greenstein, president of the Center on Budget and Policy Priorities, a Washington group that favors policies that aid low-income Americans.

“It is quite possible that we go over the cliff but only for a very short period, but as a result of which not much demand is pulled out of the economy,” he said. “When you actually go over the cliff, it creates so much consternation and builds so much pressure for resolution that it actually enables policy makers to move in ways that they are politically or ideologically or for whatever set of reasons unable or unwilling to move prior to Jan. 1.”

Shift in Momentum

Depending on the election results, political momentum and power could shift at several points early in 2013. From Nov. 6 to Jan. 3, nothing changes. The Republicans will control the House, the Democrats will control the Senate and Obama will be in the White House, where he can veto legislation he opposes.

Then, for 17 days, the new Congress will be paired with Obama. On Jan. 20, a new -- or re-elected -- president will join the new Congress. Lawmakers who think they will be in a stronger position in 2013 will have incentive to wait.

In 2010 and 2011, Democrats were unable to persuade Republicans to budge on their no-tax-increase position for what Obama calls a “balanced” approach. After the 2010 election, Obama signed a two-year extension of the George W. Bush-era tax rates and cited economic weakness as a reason why he negotiated with Republicans. In 2011, he signed an agreement to increase the federal debt limit that included spending cuts and no tax increases.

Consequences of Inaction

Now, say Democrats such as Representative Ron Kind of Wisconsin, they’re in a better position, particularly if the Treasury Department can delay the need for action on the debt limit until early 2013. If that happens, the consequences of inaction by Jan. 1 don’t include an unprecedented default on the debt that Democrats say they can’t countenance.

Geithner said at the Peter G. Peterson Foundation’s fiscal summit yesterday that Congress probably won’t need to raise the debt ceiling until early in 2013. The “sequence” of events puts the tax and spending deadline ahead of the debt deadline, he said.

If nothing happens on fiscal policy, the tax code returns to 2001 levels with higher rates on wages, capital gains, dividends and estates. Even if that’s not the tax code Democrats want, it’s one they’ll use as leverage.

“No one has been able to show in any convincing manner why the restoration of the tax rates from the 1990s would spell any doom now,” Kind said.

Vote This Summer

With only a few exceptions, Republicans have shown little willingness to budge on taxes. The House passed a bill last week that would replace the first year of automatic spending cuts to defense programs with other reductions. Boehner said the House will vote this summer to extend the expiring income tax cuts as a first step in a tax code overhaul.

“It makes no sense to get even close to that cliff,” said Representative Kevin Brady, a Texas Republican who said he was concerned about how markets and investors would react to the prospect of higher taxes and the automatic spending cuts.

Mitch McConnell of Kentucky, who leads the Senate Republicans, said in a May 10 speech that Congress should act soon to “prevent the largest tax hike in history” from occurring.

“Our offer still stands: We’re ready when you are,” he said.

The pressure of reaching or going past the Jan. 1 deadline may prompt Republicans to change their positions, said John Podesta, who was chief of staff to President Bill Clinton.

‘Clinton-Era Taxation’

“Doing nothing ends up with Clinton-era taxation, so that’s a powerful inducement to the Republicans to begin to get rational,” said Podesta, now chairman of the Center for American Progress, a Washington policy group often aligned with Democrats. “They have to be able to see, smell and taste it and that is not going to happen until we’re very close to Jan. 1.”

The likelihood of some type of agreement won’t prevent Congress from spending the next six months posturing for the fight instead of resolving it, Greenstein said.

“You can look at it from one perspective and you can’t imagine how there can possibly be a deal, given the positions,” Greenstein said. “But you look at it from another perspective, and there has to be a deal.”

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net


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