In Cliff Notes: The Deficit and the Fiscal Cliff – Part I, I provided background on the fiscal cliff and how we got into this predicament. Today, in the second and final part of the series, I cover additional details relating to the burgeoning financial crisis, including why the fiscal cliff matters, who is involved in the negotiations and when we go over the so-called cliff.
According to the CBO, the automatic tax increases and spending cuts would cut the federal deficit by over $500 billion in the next year (and by as much as $7 trillion in the next ten years). However, the impact on the economy in the short term could be devastating. Analysts contend that the policies set to go into effect would cut gross domestic product by four percentage points in 2013, sending the economy into another recession. Nearly 90-percent of Americans would see their taxes increase by an average of $3,500, according to the non-partisan Tax Policy Center.
The CBO also predicts that the unemployment rate, which is currently at 7.9-percent, would rise to 9.1-percent, with a loss of over three million jobs. There could also be major consequences for financial markets, which have already dropped about 500 points since Election Day.
The economy has shown signs of recovery, but it is simply too fragile to absorb such a shock to the system.
The principal actors in this drama will be President Obama and Speaker of the House John Boehner (R-Ohio). Other participants will include Senate Majority Leader Harry Reid (D-Nev.), Senate Minority Leader Mitch McConnell (R-Ky.) and House Minority Leader Nancy Pelosi (D-Calif). Representative Paul Ryan (R-Wis.), the chair of the House Budget Committee and recent Republican vice-presidential nominee, has also been added to the Republican negotiating team.
In July 2011, President Obama and Speaker Boehner nearly reached a deal—the “Grand Bargain”—that would have reduced the deficit by $4 trillion over ten years. The president proposed more than $2 in cuts for every $1 dollar in revenue increases ($2.8 trillion in cuts, $1.2 trillion in increased tax revenues). The spending cuts included $1.2 trillion in cuts to federal agencies, plus reductions in cost-of-living increases to Social Security recipients and an increase in the eligibility age for Medicare. Much of the $1.2 trillion in new revenue would have to come from overhauling the tax code—not from higher tax rates. The deal fell through due to the House Republicans’ staunch opposition to any tax increases.
The negotiations will likely pick up where President Obama and Speaker Boehner left off in 2011. However, since the president is coming off a decisive re-election campaign during which he made raising taxes on the rich a central issue, he is in a far stronger position this time around. He has been adamant that any deal on the fiscal cliff will have to include tax increases for Americans making over $250,000 per year. Senator Reid, Representative Pelosi and the Congressional Democrats want to protect entitlement programs (Social Security, Medicare and Medicaid) as much as possible.
The official deadline is midnight on December 31, 2012, so the Times Square Ball Drop may not be the only countdown on New Year’s Eve. But this looming deadline is hardly an unforeseen emergency. Quite the contrary, it is entirely of our elected officials’ making, as the two parties have deliberately deferred any legislative action on long-term deficit reduction until after the November 2012 elections. Now, with the election in the rear view mirror (and with political positions secured), everything is coming to a head.
It should be noted that Congress can act to change laws retroactively after the deadline. Therefore, don’t be surprised to see the deadline pass without any deal in place.
There are approximately 1.6 miles between the White House and Capitol Hill, and there will be a lot of traffic on that stretch over the next few weeks. Indeed, the president, who has been criticized for not spending enough time developing relationships with members of Congress, has already summoned congressional leaders to the White House for a meeting to discuss the impending fiscal cliff. You should also keep your eye on the Sunday morning talk shows. There are few secrets in Washington DC and, often times, the best sources of information are the politicians themselves, many of whom are fixtures on shows like Meet the Press, Face The Nation and Fox News Sunday. There is a method to their madness (aside from narcissism): each side wants to position the other to take blame in the event that no deal is reached and the government goes careening off the fiscal cliff. Thus far, the Democrats are winning the public relations battle, as 53-percent of Americans said Republicans in Congress would be more to blame for the failure to reach a deal, according to a Pew Research Center poll conducted in the days following the election.