Congress and the White House are scrambling to reach a deal to avert the expiration of the Bush tax rates, the enactment of deep budget cuts, and several other measures scheduled to take effect on January 1—known, of course, as the “fiscal cliff.”
How will they solve it? (Or will they?) The Rubik’s cube has been twisted and turned for weeks now, and we’ll overview the potential solutions that realistically remain—but first let’s clear up what exactly needs to be addressed.
At midnight on December 31, the following things will happen absent Congressional action and the president’s signature:
All Bush tax rates will revert to Clinton-era levels. This means the top marginal rate will go from 35 percent taxation to 39.6, but it also means $2,200 per year in extra taxes for average middle class families.
Expiration of the payroll tax cut, which was enacted in late 2010 as a stimulative measure. Americans will go back to paying a 6.2 percent payroll tax rate, up from the current 4.2 percent.
Expiration of unemployment insurance for 2.1 million Americans. These are the long-term unemployed who are reaching the end of their allowed benefits, unless Congress agrees to extend them. Another one million Americans would lose those benefits in the first quarter of 2013 alone.
The budget sequesters kick in. Over the next ten years, the government must realize $1.2 trillion in budget savings through across-the-board cuts in defense and non-defense spending. This is often misunderstood as $1.2 trillion in actual cuts, but some of those savings can come from simply not paying interest on debt as a result of spending reductions—so the actual amount of true budget cuts would be $984 billion. Half ($492 billion) would come from defense spending over ten years, and half from non-defense discretionary spending. (Medicaid and Social Security are protected). Adjusted for all this, it means about $55 billion in actual cuts for 2013 to the Pentagon in an across-the-board fashion, and another $55 billion from non-defense discretionary programs like the FBI, the EPA, student loans, national parks, and so on.
The annual “doc-fix” expires. There is a Medicare growth formula that ties doctor compensation from the program to the economy, but the formula’s a little hanky—for the past decade it would have seriously shortchanged doctors. So each year Congress passes the “dock-fix,” which makes up the payment difference. If the doc fix isn’t passed again this year, doctors would see a 26.5 percent reduction in Medicare payments.
The Alternative Minimum Tax patch expires. This is an extremely complicated parallel tax system conceived in 1969 that, absent a yearly Congressional patch, would force an ever-increasing number of Americans to pay higher taxes that the original AMT legislation never intended them to pay.
Many of these measures are not particularly controversial, even in highly polarized Washington. The doc-fix is passed every year and will be again this year—and Congress may even junk the entire broken doctor payment formula, as Obama has proposed, thus removing the need for the annual doc-fix charade. The AMT patch has similar wide bipartisan support, and will no doubt be passed once again. Republican Congressional leaders have reportedly already agreed to extend the unemployment insurance, so that’s very likely to get done. There is similar bipartisan agreement to end the payroll tax cut, so that’s probably falling off the cliff and never coming back. (Liberals don’t particularly like it because it undermines funding for social insurance programs, and conservatives don’t like it…for some reason nobody is quite sure about. If you’re being cynical it’s because it’s an Obama-stamped program that helps the economy).
With all that out of the way, you’re left with the heart of the debate: a tug-of-war between Democrats and Republicans on how much deficit reduction should be achieved through spending cuts versus revenue increases. There are critical sub-arguments over how deeply those spending cuts should touch defense spending and social insurance programs, and who, exactly, should kick in the extra revenue.
This is what President Obama and House Speaker John Boehner have been negotiating since the election. Obama has offered to allow all the Bush rates to stay in place up to $500,000 in revenue. He also reportedly floated raising the Medicare eligibility age, until liberals in Congress and labor unions pushed him to take it off the table. The White House then turned to cuts to Social Security and other government benefits through chained CPI, which also enraged progressives.
But by the end of those negotiations, Obama and Boehner were very close on agreeing to a spending cut versus tax increase balance, as this helpful chart from Up with Chris illustrates. But that’s also rather misleading—just because John Boehner agreed to something, it doesn’t mean Republicans in Congress would support it. We learned that in the 2011 debt ceiling negotiations.
This appears to be the case once again. Boehner, realizing he didn’t have support for his emerging compromise with Obama, pulled out of the talks and introduced the infamous “Plan B,” which would extend all Bush rates up to $1 million in revenue and nothing else. That plan failed—Boehner didn’t have the votes and didn’t even bring it to the floor. (A second phase of Plan B, a bill delaying the defense sequester, did pass).
This means that it’s quite possible House Republicans won’t support any deal that raises tax rates, period. (If not for $1 million and up, then for whom?) Needless to say this is a massive wrench in the negotiations, means there simply no deal to be had at this point. Obama will clearly not accept any deal that doesn’t raise rates—why would he, if they’re going to rise automatically in 72 hours anyway? So off the cliff we go.
Once over the cliff, Republicans in the House might be more amenable to a bill that lowers tax rates for the bottom 98 percent of earners. It’s a political distinction without any policy difference—the end tax rates are the same, but they can say they lowered taxes instead of failing to extend all rates. This “breakthrough” would set the table for a whole new round of fiscal cliff negotiations.
But before we get there, Washington is making some last-ditch efforts to avoid the cliff. Obama appeared at the White House late Friday afternoon and called upon Senate Majority Leader Harry Reid and his Republican counterpart, Senator Mitch McConnell, to craft a compromise that can pass the Senate and be sent to the House. The tentative outlines of this deal are rumored to be an extension of the Bush tax rates up to $400,000 in annual income, the AMT patch and the doc fix, putting off all sequesters temporarily, and the extension of unemployment insurance for that same amount of time. (This would technically be unconstitutional, since revenue measures must originate in the House, but they can easily get around this by taking the language of some House bill and replacing it with the Senate text).
This, however, is pure theatre to make it look like they’re trying to avoid the fiscal cliff. Maybe Reid and McConnell will come up with a deal and get it passed, and maybe they won’t. But it’s extremely hard to imagine the House passes it after that—again, they rejected tax increases for millionaires, why would they approve them for $400,000 and up?
But don’t panic too much about falling over the cliff. As has been relentlessly pointed out by smart observers, it’s a manufactured crisis to force unnecessary action on cutting the long-term debt. (Mainly through cuts to government services—the new, higher tax rates at the bottom of this cliff, of course, actually go a long way towards solving the long-term debt problem).
All that’s happened is that the action has failed to materialize. But the affects on most Americans will be minimal, despite what the hyperactive press is reporting. For one, there’s no way the tax hikes for the bottom 98 percent last for very long at all. Similarly, the harmful budget cuts can be delayed through creative accounting for a little while.
The actual cliff exists mainly for the long-term unemployed, who will stop getting checks immediately. This is intensely, and sadly, ironic. Instead of having a discussion about the jobs crisis, Washington is having a dysfunctional conversation about the long-term debt—one which, at least on January 1, is only going to screw the jobless.
But something will get done in the new year, and probably soon. Neither side will tolerate the across-the-board tax hikes. Both are rumored to be in agreement about extending the unemployment insurance. So they’ll extend the unemployment insurance and pass a tax cut bill—one that almost definitely, and thankfully, will not spare top earners. It’s just a matter of what the cutoff is.
The spending debate, meanwhile, is likely to drag on. The sequesters will be delayed or modified, and the debate over government outlays will reappear repeatedly in 2013—like in March, when Congress has to fund the government again, or whenever we hit the debt ceiling, which might be very soon. That’s not anything to look forward to next year. But don’t worry about falling off the cliff.