Posted by: danielfee | November 13, 2012

Cliff? What Fiscal Cliff?

 Now that the 2012 election is over, the so-called “fiscal cliff” is dead ahead. Obama has been re-elected in an electoral college landslide. The Democrats actually gained seats in the Senate when all the early predictions were that the Republicans would gain control of the Senate. The Republicans retained control of the House of Representatives although with a few less seats and missing a couple of its most extreme Tea Party members like Alan West and Joe Walsh. So now that the American people have spoken and an overwhelming majority say they want the two parties to work together to reach a compromise and find solutions to the debt and deficit issues, which include a mix of new revenues and spending cuts, will the House Republicans come to the table during the lame duck session to avoid the so-called “fiscal cliff”? Don’t count on it.

House Majority Leader Eric Cantor said Wednesday, in an official statement that again stressed the GOP’s opposition to higher tax rates, “There is no mandate for raising tax rates on the American people, … There is a mandate for avoiding the fiscal cliff and finding real solutions so we can make life work for people again. Higher tax rates won’t create jobs.” Surely this is mostly posturing to stake out a position for the upcoming negotiations during the lame duck session. At least Speaker of the House John Boehner has said “For purposes of forging a bipartisan agreement that begins to solve the problem, we’re willing to accept new revenue, under the right conditions.” Except what does he mean by “under the right conditions?” In the past it has meant cut the tax rates for the top income earners and for corporations so that these “job creators” will create more jobs and thereby new taxpayers, which will result in more revenue. Even though that has not worked previously, I suspect he means the same thing this time.

President Obama said continuously throughout the campaign that he wanted to follow a balanced approach, based on the framework of the Simpson-Bowles report, which includes revenue increases by eliminating the Bush tax cuts for income earned above the first $250,000 and eliminating corporate subsidies to oil and gas companies plus targeted spending cuts. He has indicated that he would accept three dollars in cuts for each dollar of new revenue. So if the President’s position is the same as it was before the election and the House Republicans are using the same rhetoric as they have for the past couple of years, then why should we expect anything to be resolved in this short lame duck session? We should not.

Not only should we expect that Congress will not act to resolve the “fiscal cliff”, I say don’t waste your time in the lame duck session and go full steam ahead over the fiscal cliff, Thelma and Louise style. But if we go over the cliff won’t that reek financial havoc in the economy come January? No, it won’t. It might cause a little panic on Wall Street and stock prices might drop, but in the overall economy it is more like starting out on a downhill bunny slope and not going off a cliff. A little panic in the markets might just be a good thing since that seems to help Congress focus their attention and take decisive action.

Back in March 2012, I wrote an article titled “Let the Bush Tax Cuts Expire. All of Them.” Please go back and read the entire article for the full context, however I made the following statement: Should Obama win re-election, he will be in a position to put forth a much broader tax reform proposal which could include adjusting tax rates, eliminating deductions and subsidies, and closing loop holes. It is possible that a tax package like this might get addressed during the lame duck session after the pressure of an election is over, but don’t hold your breath. Either way, in the lame duck session or during the next Congress, the new tax reforms will be the Obama tax policy. If Congress fails to act, the default position is the Clinton tax policy, which was successful in eliminating the deficit and creating a budget surplus for a couple of years.”

Now that the election is over and Obama did win, with a 332 to 206 electoral landslide, he needs to stand firm on pushing for his “grand bargain” on tax reform. The only unexpected twist in the election results was that the Democrats actually picked up two additional Senate seats which will strengthen their negotiating position. Also, a few of the most extreme Tea Party members were voted out of office. This provides a sliver of hope that the more moderate members of the Republican party will now be able to work across the political aisle because they can now point out that a few of the most extreme members were voted out of office due to their unwillingness to compromise. However, these guys will still be there through the lame duck session so the chances are slim for reaching a compromise and taking quick action before the end of the year. But that is fine because the “fiscal cliff” is mostly just media hype because if they called it the “fiscal bunny slope” people would not get as excited.

So what happens if we go over the cliff, I mean start down the bunny slope? First, you will see a decrease in your take home pay because the tax rates will go back to the rates we were paying when Clinton was President. Also, the employee portion of Social Security will go back to the 6% after a couple of years of temporary reduction to 4%. Yes, it might suck for a few months while Congress fights over a new tax plan, but you can be sure whatever plan gets adopted will be made retroactive to the beginning of the year. Which means whatever extra taxes you pay in at the beginning of the year you will get back at the end of the year when your tax return is filed. A continued reduction in the Social Security payroll tax deduction is less likely to be extended if a “grand bargain” can be achieved.

When the new Congress gets sworn in, in January 2013, the dynamic of the tax and deficit reduction discussion will change significantly. First, the new members of the House and Senate will enter office knowing they are expected to work together to find a balanced approach, which means revenues and spending cuts to reduce the deficit. Second, with some of the most extreme voices gone from Congress, the temperature of the discussions should be lower which should provide some room for compromise. But the most important change is that as of January 1, 2013 when the Bush tax cuts expire, every Republican in Congress will be free from the Grover Norquest pledge to never raise taxes. They will go up automatically with no action on the part of Congress. The tax rates for 2013 are scheduled to change as follows: the 10% rate will be collapsed into the 15% rate, the 25% rate will become 28%, the 28% rate will become 31%, the 33% rate will become 36%, and the 35% rate will become 39.6%.

Once this occurs it will put the new Congress in a position to negotiate new tax cuts with the President, which we should start calling the Obama tax cuts. The President has said many times that he wants to keep the current tax rates for all income below $250,000, but above that level he wants the rate to return to the Clinton rate of 39.6%. So the Republicans in Congress will be faced with a decision; do they vote for tax cuts which would apply to 98% of Americans or do they become the “no tax cut” party because they hold out for the last 2%? But this is just Obama’s initial position. He has indicated that he is willing to go for more sweeping tax code revisions which leaves plenty of room for negotiating. But the bottom line is tax revenues will have to go up as part of the deficit reduction plan.

There will be a lot of noise and hand wringing over the next couple of months as the media, and especially the business media, hypes the dire consequences of the fiscal cliff. Don’t let it distract you. Remember how big of a financial disaster Y2K was going to be? When we woke up on January 1, 2000, the biggest problem we faced was our own personal hangovers from too much celebrating of the new millennium. The same thing will occur this New Years Day. Once everyone realizes the “fiscal cliff” was nothing more than a start down the bunny slope, then the new Congress can get down to business discussing a new tax policy with a clean slate. Major changes in the tax code only occur once in a generation or two. Once the direction is set then other changes are usually minor in comparison and they keep moving the tax code in the same direction until the next generational change occurs. I believe we are at that inflection point right now. For the past thirty plus years we have been following a tax policy based on a trickle down economic theory which has resulted in income and wealth being redistributed from the middle class to the top. Obama stated repeatedly throughout the campaign that he wanted a fairer tax system, which by necessity means that it will no longer favor the top 2% of income earners. It is time for Obama to go for big changes with a “grand bargain” and not just a partial extension of the Bush tax cuts.

Remember during the primaries in 2008 when Obama made the statement that he wanted to be a transformational President like FDR and Reagan? This statement drew plenty of criticism from the Hillary Clinton supporters and the Bill Clinton fans. But no matter how effective Bill Clinton’s economic stewardship was during his eight years, did he really make a generational transformation? Considering that George W. Bush was able to undo most of Clinton’s progress and make a quick pivot back to supply-side trickle down economics and turn Clinton’s budget surplus into a record deficit, it is hard to conclude that Clinton was transformational. However, once the Bush tax cuts have expired, the slate is cleared for a big tax policy transformation. Obama should go big and put a super-sized grand bargain on the table. From a political perspective he will have one opportunity to achieve this goal, and come January 2013 that will be the time. A piecemeal approach to tax reform and deficit reduction will not work.

So will Obama seize the opportunity and go big? If his past history is any indication, the answer is yes. Despite all of the rhetoric that was heard during the election season that Obama had no record of accomplishments in his first term, Obama accomplished major transformational changes in the areas of health care, energy, and education which were three of the four pillars of change that he outlined when he ran in 2008. The fourth pillar of transformational change was the economy, but it had to be placed on the back burner until the economic collapse which created the great recession could be addressed. In addition to the four pillars, we should not forget to mention the changes in the military which included: ending the Iraq War, putting the end to the Afghanistan War in to motion, shifting the military focus to southeast Asia, and changing the military policy and culture on allowing gay service members to serve openly. These were transformation changes for the military.

In health care, whether or not you oppose or approve of Obamacare, it was without a doubt a transformational change to the American health care system which had not seen any significant changes in more than 40 years. In addition, the American Recovery and Reinvestment Act (aka stimulus bill) provided $50 billion over five years (this compares to the $100 million Bush provided for health IT) to bring the practice of medicine into the 21st century of information technology, which in the long run will produce big savings by eliminating duplicative and unnecessary procedures, replacing inefficient records and billing processes and reduce medical errors which can be costly.

In energy, the all-of-the-above strategy that Obama said he would follow is being implemented with the $90 billion in funding provided by the stimulus bill. The electrical grid is the process of being updated to what is referred to as a smart grid, employing new technologies to save electricity. So far renewable electricity has doubled and the number of wind, solar and geothermal projects on federal land has increased from zero to twenty-nine in just three years. But one of the coolest and potentially game changing energy technologies has been developed by ARPA-E, a new department within the Energy Department, in conjunction with a couple of universities and a private sector company is what are called “electrofuels.” This radical new technology was invented by the ARPA-E team. Using this technology, a team at North Carolina State University in collaboration with a Colorado bio-tech start-up company, has already brewed up a batch of electrofuel which has been used to power a jet engine. If this technology can be scaled up and produced cost effectively in large quantities, which still must be proven, is it no wonder that the old fossil fuel industries of oil, gas and coal companies are concerned about their future?

In education, the “Race to the Top” program has transformed the national conversation about education reform and has been praised by both Democrats and Republicans. The grants have been used to create a “pipeline of innovation in education” and is changing the way schools are doing business. In addition, Obama eliminated the more than fifty year practice of paying subsidies to banks to act as middlemen for the federal guaranteed student loan program. The savings were used to expand Pell Grants and to make it easier for students to repay their outstanding student loans after graduation.

With his track record of following through on transformational changes in health care, energy and education, I fully expect that Obama will move forward with a transformational change to economic and tax policy. The time is ripe for such a change to occur. Then he will be free to move on to the next big transformational change – immigration policy.

 

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