This past week, a serious and divisive issue was finally laid to rest in America. A deal was struck, terms were reached and a framework was set up that should make the next ten years calmer, brighter and more prosperous. I refer, of course, to the end of the NHL lockout.
What, the fiscal cliff? Oh, that was an ugly, bitter and ultimately pointless deal where Congress, in a moment of crisis, decided to punt (or ice, if you prefer the hockey theme) instead of negotiating and reaching an actual deal. Instead of boosting our recovery and making inroads against debt, Congress pushed the issue down the road for another two months. Whether your understanding of the fiscal cliff is on a Paul Krugman level, or is more Kathy Griffin, it never stops being helpful to break the issue down to its simplest parts. Let’s review.
What is the fiscal cliff?
While you would be better off reading an article tailored to this particular question, the basics of the fiscal cliff are pretty straightforward. It consists of tax increases, most notably in marginal income tax rates, payroll taxes and the capital-gains tax, along with spending cuts. These spending cuts would occur in Medicare (in cuts to rates paid to doctors), in unemployment (by returning unemployment to its pre-recession form) and through a mechanism known as the sequester that would cut discretionary government spending by $1.2 trillion across the board. All of these increases and cuts were scheduled to go into effect on Jan. 1, 2013.
One of the major goals of the 112th Congress in the past few months has been to reach a deal that would soften the impact of these tax hikes and spending cuts in a way acceptable to both parties. Such a deal would ideally boost the recovery, as well as build a structure to tackle our rising deficit in an organized and reasonable fashion.
Did Congress reach that deal?
Of course not. Congress did, in the end, reach a deal over the fiscal cliff. However, by the time that deal was reached, we were already sort of over the cliff. The fiscal cliff bargain (officially the American Taxpayer Relief Act of 2012) was not passed by both houses of the legislature until Jan. 1, 2013, at 11 p.m.
The timing of this deal meant that most of the especially threatening parts of the fiscal cliff (most notably, the income tax hikes and the sequester) were unable to affect the economy. The late passage of the bill, though, angered lawmakers on both sides of the aisle and had significant impact on the deal that was ultimately reached.
What were the terms of the final deal?
On the tax side, the fiscal cliff bargain broadly kept taxes on the “middle class” (a term that has lost all meaning in Congress) down, while allowing tax increases on the richest Americans.
On Jan. 1, the tax cuts put into place during the Bush administration were scheduled to end. Americans making over $400,000 a year if filing singly or over $450,000 a year if filing jointly will now see their marginal tax rates increase. All income above that level will now be taxed at 39.6 percent, where it was under President Clinton. Additionally, the capital gains rate (a tax on income earned through investment) will rise to 20 percent from its Bush-era level of 15 percent. Tax deductions for the richest Americans are going to be slowly phased out, while the alternative minimum tax (think of it as a way to ensure the wealthiest Americans cannot cheat the tax system) is going to be permanently pegged to inflation.
On top of all of that, estate taxes above $5 million will rise to 40 percent, while tax credits for the poorest Americans, notably tax credits for college and the earned income tax credit, will be extended. The payroll tax holiday that has existed for the past two years will end, meaning that employers will now withhold an additional two percent on paychecks. Finally (and less importantly to college students), a number of tax breaks for corporations are extended.
And what about spending?
Spending is much simpler. Unemployment benefits are extended for another year, the farm bill is extended for another nine months, a pay freeze on most government workers (Congress is the main exception) is lifted, the so-called Medicare “doc fix” is extended, and the sequester is punted down the road for another two months.
Wait, wait, back up. The farm bill?
The farm bill. I know it might sound boring and unimportant, but the farm bill is one of the most important parts of the modern U.S. economy. Rural lawmakers, especially in the Senate, are capable of wielding enormous amounts of power despite representing smaller populations, and historically have leveraged that power to create massive agricultural subsidies.
Many of these subsidies have been controversial, but they have helped to keep the price of food in America consistently low (for example, the price of dairy would have doubled without the farm bill extension). The 2008 recession and the fiscal cliff pushed agriculture to the backburner, though, and there is a growing divide between rural lawmakers and the rest of Congress.
What about the sequester?
Nothing about the sequester, really. The sequester now goes into effect on Mar. 2, 2013 instead of on the first of the year. Republicans demanded this delay be paid for with $12 billion in cuts over the next two years and some business about 401(k)s and Roth IRAs, but in practice Congress is only delaying the issue.
What do Democrats stand to gain from this deal?
In theory, this is a victory for Democrats. The “middle class” has been protected from tax hikes, while taxes on the rich (which the estate tax, capital gains tax and alternative minimum tax effectively are) have risen. The sequester has been delayed, earning valuable negotiation time, while key entitlement programs have been saved. The spending cuts from the sequester delay are a minor loss, but most Democrats would probably consider them a cost worth paying.
All of this will be worthless for Democrats if Republicans win in two months.
What do Republicans gain from this?
Republicans got a couple small victories and have set themselves up to potentially win one very large victory in March. The small victories come in the form of the cost of the sequester delay and in the timing of the bill. Had the fiscal cliff bargain been reached before the tax increases came into effect, Republicans would have voted to raise taxes on the richest Americans. Since the passage came after the first of the year, though, Republicans technically voted for a tax decrease for most Americans. It is just a technicality, but semantics like this are important when election season rolls around.
The bigger victory for Republicans is on the sequester delay. Originally, word out of Washington seemed to indicate the sequester delay would be for three months or a year, depending on which side got its way. Either way, the sequester would be delayed long enough for lawmakers to reach some sort of deal beforehand.
The final deal, though, ended with a sequester delay of only two months. This lands the sequester delay very close to the expected battle over the debt ceiling, creating a perfect fiscal storm for Republicans. The debt ceiling, as you may recall from last year’s acrimonious debate, limits how much money the American government can borrow to sustain its spending. Since we go into deficit every year, the debt ceiling, in practice, represents a hard and fast limit on our spending. Remembering the shutdown of 1995 and 1996, Republican leaders in 2011 strove to reach a bargain with Obama and Democratic leaders in Congress. The resulting deal, while unpalatable to pretty much everyone and a key factor in the creation of the fiscal cliff, worked.
This time around, Republicans want to exploit the sequester to aid in their negotiations on the debt ceiling, and vice versa. If Democrats won’t accept their terms on the debt ceiling, they will threaten to let most of the sequester go through, a much more threatening prospects for Democrats than it is for Republicans. If Democrats consider letting defense cuts go through, Republicans will become recalcitrant on the debt ceiling. Republicans are gambling that they can leverage both these situations to swing public policy, or at least public opinion, their way come March. It remains to be seen if they are right.
What happens now?
That’s the $1.2 trillion question. Both sides are already gearing up for a political fight in March that could be even more aggressive and acrimonious than the fiscal cliff battle or the first debt ceiling debate. Obama, for his part, has said that he refuses to sign any sort of bill that puts conditions or limits on the debt ceiling raise, meaning he either gets the clean raise he wants or the government shuts down. He is betting, for his part, that if the government shuts down then America will blame Republicans.
Congressional Republicans, for their part, are gearing up for a fight. Newt Gingrich’s warnings not withstanding, Republican leaders are showing every sign that they are ready to fight. Senate Minority Leader McConnell is saying that taxes are off the table, and everyone’s favorite orange Speaker of the House is coming fresh off of several significant losses and will no doubt do his best to be seen as an ardent conservative and strong leader.
In short, Congress has achieved a deal that neither side is happy with. It has set itself, and America, up for another bitter fiscal battle in just two months. It has solved none of our long-term problems and very few of the short-term ones. In the ensuing chaos, you can pretty much guarantee that no significant movement will occur in Congress on issues that many Americans care about, such as gun control, climate change and immigration. The first few months of 2013 promise to be ugly, bitter and potentially disastrous to our economy.