The subtext of the fiscal cliff battle between Democrats and Republicans is a dispute between going fast and going slow.
Democrats want to capitalize on the political momentum from President Barack Obama’s Nov. 6 re-election and reach an agreement that moves policy in their direction with higher taxes on top earners. Republicans want to avert the $607 billion cliff while extending the current lower tax rates, yet they have a good reason for waiting to endorse a deal. Every day puts the 2012 election farther away and brings the country closer to reaching the $16.4 trillion debt limit, an action-forcing event that can give Republicans a political edge.
The competing incentives may make it difficult for lawmakers to reach a deal. Because both parties sense potential advantages, neither may be eager to bargain away anything. Both sides will gauge each other’s willingness to budge and try to pin blame on the other side for failure to reach a deal, even as they negotiate and express a willingness to work together.
“If it were easy, it would already have been done,” Representative Tom Price of Georgia said in an interview yesterday. “Everybody appreciates the remarkable consequences of not addressing these things. The bondholders and the credit rating agencies are just waiting for us to give them an indication and a sense that we’re actually going to solve this.”
The tension over the speed of an agreement is evident in the first moves both sides are taking in advance of the first bipartisan meeting between Obama and congressional leaders, scheduled for Nov. 16 at the White House.
Obama is meeting with labor leaders today and business executives such as David Cote of Honeywell International Inc. (HON:US), Alan Mulally of Ford Motor Co., Ursula Burns of Xerox Corp. (XRX:US) and Kenneth Chenault of American Express Co. (AXP:US) tomorrow. He’s trying to build support for extending middle-class tax cuts now and designing a “balanced” approach that relies on spending cuts and tax increases that would require immediate concessions from Republicans.
“The emphasis should be acting on the cliff and not kind of jousting,” Representative Sander Levin of Michigan, the top Democrat on the House Ways and Means Committee, said in an interview Nov. 8. “We need to act on it, and the Republicans need to listen and learn.”
Republicans, meanwhile, have been warning against major agreements in the lame-duck session of Congress that starts today. They are talking about creating a “bridge” now that averts the cliff and sets up a process for overhauling entitlement programs and the tax code in 2013.
“Most of these things tend to respond to a deadline,” said Price, the fifth-ranking Republican in the House. “And whether the deadline is the end of this Congress or the debt ceiling, I’m hopeful that we can reach an agreement prior to the end of the year, just because I think it’s better for the economy and jobs.”
If Congress doesn’t act by Dec. 31, the tax cuts enacted in 2001 and 2003 and extended in 2010 would expire, along with a payroll tax cut and expanded unemployment insurance. The average U.S. household would face higher 2013 tax bills, averaging $3,446, according to the nonpartisan Tax Policy Center. Across- the-board spending cuts in defense spending and other federal programs would take effect as well.
The Congressional Budget Office projects that inaction would cause a recession in the first half of 2013. Averting all of the policy changes in the cliff would preserve 3.4 million jobs, the CBO said in a Nov. 8 report.
The biggest Treasury rally in five months is underlining market concern that the two sides will fail to reach a deal to head off the mandated spending cuts and tax increases. The yield on 10-year Treasury notes declined one basis point, or 0.01 percentage point, to 1.59 percent at 10:29 a.m. in New York after dropping to 1.57 percent, the lowest level since Sept. 5, signaling confidence in U.S. government securities as a haven. The Standard & Poor’s 500 index rose 0.1 percent to 1,381.57 at 10:19 a.m. in New York.
The consequences of inaction create the potential, if the country goes beyond Jan. 1 without a deal, for an even more high-stakes negotiation. Take-home pay would shrink as tax withholdings increase. Some taxpayers would face immediate bills for breaks that expired before 2012. Defense cuts would start taking effect. Both sides would blame each other.
“Both sides have a fair amount of leverage at their disposal,” said Jon Traub, managing principal of tax policy at Deloitte Tax LLP in Washington, adding that Obama can get higher taxes on top earners by refusing to sign a bill. “Republicans in the House have a fair amount of leverage in that any tax bill needs to originate in their chamber, and certain elements of the fiscal cliff would be disconcerting to Democrats.”
And the debt limit would become an issue. The Treasury Department has said that the U.S. will reach the debt limit by the end of 2012, and then the Treasury will begin using special measures to extend the date of default to “early in 2013.”
If Republicans credibly threaten to let the country default on its debt, they can recreate the leverage they had in 2011, when Obama agreed to deficit reduction only in spending cuts.
Last year, the battle around raising the debt ceiling gave Republicans political leverage because it was something the president needed and risked serious financial fallout, said David Walker, a former U.S. comptroller general who advocates a deficit-reduction agreement.
“They may not want to give up on it,” said Walker. “On the other hand, the last time was such an embarrassment and it caused market disruptions and caused the government to lose credibility with the American people.”
Democrats haven’t articulated a clear strategy for responding to another Republican debt-limit demand.
“It’s there, and it has to be dealt with and I certainly hope folks have recognized the errors of their ways the last time,” Representative Mike Thompson, a California Democrat, said in an interview. “The failure to deal with it last time in a timely manner cost us some economic recovery, cost us a credit rating. It was very poorly handled, and we don’t need to go through that again.”
A deal on averting the fiscal cliff may complicate talks about the debt limit, said Traub.
The across-the-board reductions were created to satisfy Republicans who insisted that a debt limit increase in 2011 be accompanied with dollar-for-dollar spending cuts. Eliminating some of those cuts, he said, may be seen as reneging on the spending-cut commitment.
“Obviously, the president is aware that getting a debt limit through the House is very difficult,” said Traub, who was staff director for the House Ways and Means Committee under Republican Chairman Dave Camp.
Price said that dollar-for-dollar rule still stands, and that the across-the-board cuts, though not the wisest way to cut spending, are still better than no spending cuts. He said the fiscal cliff and the debt ceiling don’t necessarily need to be linked.
The two sides are particularly divided over taxes. Obama and the Democrats claim a mandate coming from the election that rich people must pay more.
“What was put before the people was a tax approach that maintains the middle-class tax cuts and not the tax cuts for upper-income,” Levin said. “There was a verdict on that, and so the Republicans should listen, should heed that verdict.”
House Speaker John Boehner, in his comments since the election, has emphasized his objection to higher tax rates and said Republicans would consider ways of increasing tax revenue. He hasn’t said whether that additional revenue would come only from economic growth or whether he would accept what Democrats and congressional scorekeepers would call tax increases.
While saying that revenue from economic growth was preferable, Price said that something Democrats would accept as a tax increase would be “part of the negotiation” that will occur.
“If we can back into a number that makes sense for that increase in revenue and reduction in spending, all being on the table at the same time, then we’re open to that discussion,” he said.
Both sides have left room for a compromise that would curtail tax breaks to pay for preserving current rates. Neither side has embraced such a deal, which could hurt nonprofit groups that rely on tax-advantaged charitable contributions, breach Republicans’ no-tax-increase pledge and contradict Democrats’ insistence on returning top tax rates to their levels under President Bill Clinton.
Time is short for action, said Michael Mundaca, co-director of national tax at Ernst & Young LLP in Washington, who worked at the Treasury Department under Clinton, President George W. Bush and Obama.
Lawmakers return to Washington for votes today and will break next week for Thanksgiving. Price said he doesn’t expect lawmakers to “put pen to paper” until after the holiday.
Both sides know it will take months to hammer out the details of a deal, said Tom Coburn, an Oklahoma Republican who is part of the Senate “gang of eight” working on a bipartisan debt-reduction plan.
“It’s going to be a tough deal to get that figured out in six weeks,” Coburn said. In the end, the deal “probably doesn’t have anything to do with timing.”
Even if they reach a deal, congressional leaders would have to turn it into legislative text, sell it to rank-and-file members and overcome procedural hurdles and political opposition.
“The calendar is not working in anyone’s favor at this point because there really is not a whole lot of time to address a whole lot of issues,” Mundaca said.
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