One cliff at a time

John Boehner

American politicians have not disappointed. After creating the fiscal cliff themselves, they proved incapable of avoiding it entirely and have set themselves up for another round of gruelling negotiations on raising the debt ceiling and replacing the sequester (across the board spending cuts worth $110 billion per year) pretty much as soon as the current deal is signed into law. This latest law jewel emanating from a dysfunctional Congress extends the Bush tax cuts for individuals and couples earning less than $400,000 and $450,000, respectively. Above that threshold the marginal rate will rise from 35% to 39.6%. Inheritance taxes will go up from 35% to 40% after the first $5m for individuals and $10m for couples, whilst taxes on capital gains and dividends will rise to 20% from the current 15%. The enhanced unemployment benefits affecting some two million people will be extended for another year whilst the tax credits for poorer and middle-class families have been extended for another five years.

Lawmakers have not exceeded our expectations then. The deal does nothing to address the spending cuts, which have been delayed for a few months, and the debt ceiling, which the Treasury reached on Monday (although it still has some wiggle room to allow it to borrow for another two months). Furthermore, the payroll-tax cut was allowed to expire as scheduled meaning that workers’ purchasing power will decrease by about $1,000 each, causing a significant drag on the economy. Entitlements, which many analysts agree will be a key driver of the burgeoning US debt in the future, have not been tackled although they will probably become a sticking point in the next negotiations as Republicans will demand cuts to them as a price for raising the debt ceiling. Given that they won not a single spending cut in the latest round and backed down on increasing taxes for the rich, they will most likely not be enthused by a sincere spirit of cooperation in the next round. 

President Obama, for his part, has not hesitated to brandish this deal as a Democrat victory and set a worryingly belligerent tone for the next round of negotiations by claiming that “If Republicans think that I will finish the job of deficit reduction through spending cuts alone…they’ve got another thing coming.” His key request that taxes should go up on the rich always made more political than economic sense: higher taxes for the rich should raise about $600 billion over a period of ten years against a projected deficit of $10 trillion over the same period. In other words, pocket change. But it does chime in well with the public sentiment that the rich have weathered the crisis at the expense of the poor and now need to pay their dues. It also goes some way towards appeasing those on the left who perceive Mr. Obama as too often caving in to the demands of the Republicans on protecting the rich. Unfortunately, it does not foster bipartisan cooperation (something Mr. Obama had campaigned on) and basking in symbolic political victories should not come at the price of achieving significant economic ones for the good of the country. Given the unlikelihood of either side steering clear from ideological battles and the fractured chaos of the G.O.P., let us see what deal an ineffective Congress can rustle up next.

Who's the chicken?

From: DonkeyHotey

The world waits with bated breath for an outcome of the ongoing fiscal cliff talks in Washington with much the same anticipation that accompanied the end of the Mayan calendar on December 21. As it happened the end of the world was not to be, and sadly, a grand bargain on how to tackle America’s sickly finances may not grace the news headlines either. There will in all probability be a last minute deal, a fudge of sorts that merely postpones a long-term solution to America’s burgeoning debt.

Back in 2011, the Obama administration came to blows with the Republicans on raising the debt ceiling for the US government and as part of the compromise that broke the impasse both parties agreed to point a gun to their foreheads to ensure a long-term solution was agreed on by the end of this year. This gun is the so-called fiscal cliff: a combination of draconian tax increases and spending cuts worth about 5% of GDP over a year that would kick in on January 2^nd and are likely to topple America’s fragile economy back into recession. No one in their right minds would contemplate rolling out such a harsh package at this stage of the American recovery, and indeed the whole world (American politicians included) assumed the fiscal cliff would be enough to ensure a deal is passed in Washington. The question now is what kind of deal.

Initially Mr Obama had pushed for a rise in tax rates for those earning over $250,000 a year, subsequently rising that threshold to $400,000. He has also agreed to change the way Social Security benefits are indexed to inflation and called for a two-year extension of the debt ceiling. For his part John Boehner, the Republican speaker of the House of Representatives, has also made some concessions. He had conceded that tax rates could rise for those earning over $1m a year and the revenue he is prepared to see gathered over ten years now stands at $1 trillion.  However the suicidal polarisation of US politics makes any reasonable deal unpalatable to one or both of the parties.

The concession to allow the Bush-era tax cuts to expire for those earning over $1m a year came under Mr Boehner’s Plan B, which still left a fiscal tightening of nearly 3% of GDP over a year. As it happens even this largely symbolic tax rise (the Americans affected by it number about 400,000, or 0.3% of tax filers) was anathema to the fiscal hawks in the G.O.P. and so they promptly proceeded to reject it.

The odds now seem to be in Mr Obama’s favour. Whilst a grand bargain which involves a package of spending cuts and tax rises worth at least 2% of GDP to stabilise the debt level is not likely to emerge from the last-ditch negotiations going on right now, the G.O.P. has manoeuvred itself into a corner. Mr Obama’s fall-back position involves a minimalist bill that would prevent an income tax rise on the middle class and extends vital unemployment insurance for Americans looking for a job. If Republicans voted against this for whatever ideological reasons, they would essentially be voting for a tax rise on ordinary Americans. Given that recent polls have found that 53% of Americans would blame the Republicans if the country toppled over the cliff, it is a powerful incentive for them to compromise to avoid becoming the subject of public opprobrium and being eternally branded as the party of the rich as the whole country reels back into recession.

Unfortunately the deadlock is not just about economics. November’s election painted a dreary picture in terms of the polarisation of the country. The number of states that was decided marginally, i.e. by five percentage points or less, decreased from six to four, meaning that incumbents have safer seats and can ignore the needs of the country in favour of their constituents. More worryingly however is the fact that these seats may be safe from the rival party, but, especially for the Republicans, they dramatically increase the battles at the primaries. To vote for a tax rise now would be for many Republicans analogous to committing political suicide. Of course there are moderates within the G.O.P., and both their political futures and the passing of a deal on the fiscal cliff rest on them being able to form a large enough block to give them political cover. The ideological polarisation within the G.O.P. therefore matches that of the entire country, and the repercussions of such a divide are crucial not just for the fiscal cliff but for the other items on Obama’s agenda, such as climate change and gun control.

Whatever final deal emerges then, it will most probably not be a definitive one for the deficit but it will give us a clue as to the turn American politics will be taking. As ever, it’s not just the economy, stupid.