Thank goodness for the House G.O.P. ultras—Eric Cantor, Allen West, Michele Bachmann, Steve Scalise, and the rest of the crazy gang who voted against the fiscal-cliff deal. That’s what they must be thinking in the White House right now. A few days ago, President Obama was facing a potential rebellion on the left for caving to the Republicans. Now many progressives are having second thoughts. If the Republican ultras hate the deal so much, they are thinking, perhaps it wasn’t such a bad one after all. “Calm Down Liberals, Obama Won,” said the headline over an upbeat post from Ezra Klein that encapsulates the revisionist view.
Having already posted two lengthy pieces pieces criticizing the deal, I’m sticking with my conclusion that it wasn’t up to much. (Nouriel Roubini agrees with me.) But I’m dubious enough about all instant judgements, my own included, to believe that the counter view deserves a hearing. So here, for the sake of argument, is a more optimistic take on the politics of the agreement, its policy substance, and its likely impact on the economy. For reasons that should become clear, I’ll call it the Clintonian case for the defense.
Politics: The knock on Obama is that, having given up the bargaining power bestowed upon him by the fiscal cliff for not very much in return, he now has to face an embittered G.O.P. wielding the threat of refusing to raise the debt limit. Robbed of leverage, the President may be forced to buckle to Republican demands for radical cuts in spending programs. That’s certainly a possibility. But what if this G.O.P. threat turns out to be as hollow as the White House’s initial one to go over the fiscal cliff unless the Republicans agreed to raise the tax rates of everybody earning more $250,000 a year?
To be effective, a threat has to be credible. Pushing the U.S. Treasury to the brink of a default would entail lots of nasty things: financial-market mayhem, a government shutdown, debt downgrades, and so on. Would the G.O.P. really go that far? Some parts of it might. On Wednesday, I was on “Morning Joe” with Pat Toomey, the right-wing Republican senator from Pennsylvania, and he said explicitly that his colleagues should be willing to shut down the government. However Toomey, whose fellow conservatives have been lambasting him for supporting the fiscal-cliff deal, doesn’t represent the G.O.P. leadership. Veterans like Mitch McConnell and John Boehner well remember how much damage Newt Gingrich did to the Party by shutting down the government in 1995. As the dispute plays out, they will be wary of falling into the same trap that Bill Clinton set for Gingrich.
Of course, that assumes that the G.O.P. leaders are rational actors, which, strange as it may sound, they are. “Republicans make a big show of being unreasonable, but they’re not nearly as crazy as the tea party would have you believe,” Klein notes. “In the end, they weren’t even willing to go over the fiscal cliff. The debt ceiling would do far more damage to the economy than the fiscal cliff, and Republicans would receive far more of the blame.” Assuming that McConnell and Boehner don’t want to risk meeting Gingrich’s fate, they may well be forced into the same awkward position that Obama found himself in a few days before the fiscal-cliff deadline: publicly hanging tough, privately looking for a face-saving compromise. At that point, sometime toward the end of February probably, the President, who has pledged not to negotiate over the debt ceiling, would be well placed to dispatch Joe Biden back up to Capitol Hill for a bit of hand-holding, if not actual bartering.
Policy Substance: In judging this extended budget negotiation—eighteen months and counting—most liberals and progressives are interested in two things: finding new revenues to fund the federal government, and reducing inequality. Economists and financial-market participants (including buyers of Treasuries) are more interested in how any reforms impact the deficit. Obama is trying to find an approach that satisfies both constituencies.
In failing to extend the payroll-tax cut, Obama raised a tax that is regressive. (It will rise from 4.2 to 6.2 per cent, but is only levied on the first $113,700 of pre-tax income, so the effective rate for the wealthy is far lower than for the working poor and middle class.) On the other side of the balance sheet, by raising income-tax rates on the wealthy for the first time in twenty-two years, and by fiddling with other tax measures, the President has taken a modest but symbolically important move towards tackling inequality. I and others have made much of Obama’s concession in raising the top-rate threshold from to $450,000. At the same time, however, the deal reintroduced a cap in applicable tax deductions that will raise the effective tax rate faced by many taxpayers earning upwards of $250,000. Of the six hundred billion dollars, or so, in new revenues that the deal will generate over the next ten years, almost two hundred billion will come from the the so-called “PEP and Pease” clauses of the bill, which include the new limits on deductions.
Emanating from a White House team largely staffed by former members of the Clinton Administration, this is another typically Clintonian tactic. Rather than pushing for a big increase in tax rates, which could spark a political blowback, do things that most people won’t notice, such as bolstering income-support programs for the near-poor and tightening the caps on tax deductions that rich people can take. If you do this effectively, ultimately you might well get a better result than you would get by grandstanding.
Obama promised all along to pursue a “balanced” approach to deficit reduction, which he has defined as two dollars of spending cuts for every dollar of new tax revenues. (If you think that’s a funny definition of balanced, you are right. But that’s not the point here.) In 2011, the two sides agreed on $1.5 trillion of discretionary spending cuts over the next ten years, with no revenue increases. The fiscal-cliff deal will raise another $600 billion, or so, in new revenues. That takes the total to about $2.1 trillion. Add in another $300 billion in savings on interest payments, and you get to $2.4 trillion.
From a deficit-reduction perspective, the good news is that’s a pretty substantial number. The bad news is, because the deficit has gotten so large, it’s not big enough to stabilize the debt-to-G.D.P. ratio, a metric that the markets follow closely. To accomplish that, according to calculations by Bob Greenstein, of the Center on Budget and Policy Priorities, we still need another $1.2 trillion in deficit reduction.
Let’s assume that, in the coming showdown over the spending sequesters and the debt ceiling, the two sides can agree on the $1.2 trillion figure as as common goal. If all of the additional deficit reduction were to come in the form of spending cuts, Greenstein points out, the ratio of cuts to revenues would be more than five to one, which isn’t balanced in any sense of the word. But if the White House can make good on its intention of demanding a one-for-one split in spending cuts and revenues, the overall ratio would be less than two to one, which would meet the White House’s target. (To be precise, the ratio would be 1.75:1.)
Of course, that’s just another way of saying that a lot depends on what happens over the next couple of months. But it does imply that the goal of stabilizing the nation’s finances hasn’t yet been abandoned, and that Obama hasn’t necessarily given away the store.
The Economy: Perhaps the strongest argument for the fiscal-cliff deal is the one that has been getting the least attention in the political press—the macroeconomic one. Obama has removed the threat of higher income-tax rates for all and, for the moment, draconian spending cuts; if he holds the line on cuts, he will have greatly reduced the chances of the economy being knocked back into a slump, and just may have cleared the way for a substantial pickup in the recovery.
According to the Congressional Budget Office, the expiration of the Bush tax cuts and the imposition of automatic spending cuts would have reduced G.D.P. growth by about four per cent in 2013, enough to bring about a new recession. Largely as a result of a rise in payroll taxes, which affects everybody, the fiscal-cliff agreement will also act as a drag on the economy, but the hit will be much smaller. According to the consensus on Wall Street, the negative impact on G.D.P. will be about one and a half per cent—enough to reduce the expected growth rate from about 3.5 per cent to about 2.0 per cent. That’s not great, but it’s better than many other advanced economies are managing, and it could conceivably be an underestimate.
After three and a half years of a sluggish recovery from the bust of 2007-2009, most economists are apprehensive about predicting growth of three or four per cent, or even higher, which is what we usually see during a rebound from a deep recession. I’m wary, too. This time last year, I was pretty optimistic about the economic outlook, but the combination of troubles abroad (especially in Europe); cutbacks in spending at the federal, state, and local levels; continued credit constraints facing small businesses; and reluctance to make capital investments on the part of big corporations; made it another disappointing year.
If the White House can reach an agreement with the Republicans in the next couple of months, with the cuts and revenue increases being phased in to avoid an immediate shock to the economy, it’s just possible that 2013 could be the year when the economy finally shows some vigor. Yes, the fiscal-cliff deal will be a drag, but it will be at least partly offset by a stabilization in government spending at the state and local levels. And it’s not out of the question that other factors could offset it completely.
Thanks to the actions of the Federal Reserve, mortgage rates are at a fifty-five year low. Consequently, the housing market is finally picking up. Banks, seeing their capital ratios and share prices rising, are becoming more willing to lend. The rising prices of real estate and stocks makes people feel wealthier and more willing to spend. Gas prices are falling, which leaves them more cash to spend on other stuff. If business executives see demand picking up and the threat of political turmoil receding, their “animal spirits” may finally perk up, and they may start spending some of the cash reserves they have been accumulating. In some industries it is already happening. After a strong 2012, car manufacturers are expanding their production lines. The energy industry, enthused about the prospect of cheap shale oil and gas, is enjoying a mini boom. Construction, which usually acts as the economy’s locomotive during a recovery, is picking up.
If the pace of economic growth were to accelerate, and the faster growth was sustained for a while, a lot of things would look very different. The budget deficit, which is currently expected to fall to about six per cent in fiscal 2013, and about four per cent in 2015, would fall more quickly, and expectations of future deficits would be transformed. That isn’t supposed to happen—long-term budget forecasts are meant to take account of the vagaries of the economic cycle—but often it does. Here too, Bill Clinton is the model. In 1993, his Administration raised taxes and agreed to spending restraints to reduce the deficit. During the ensuing years, the economy grew pretty rapidly, and the fiscal outlook was transformed. By 2000, it seemed possible that within a decade or so the country would pay down its entire stock of debt.
With the debt mountain now standing at about seventy-three per cent, we can be well-nigh certain that’s not going to happen again. But the broader argument stands. Healthy economic growth makes a lot of other problems seem more manageable, deficits and debts included. Imagine a situation two or three years from now in which the economy was growing at an annual rate of three to four per cent, the unemployment rate had fallen to below six per cent, and the deficit was less than four per cent of G.D.P. In such an environment, few people would care very much whether Obama had set the top rate threshold at $250,000 or $450,000 during the fiscal consolidation at the start of his second term, or about the precise ratio of spending cuts to revenues.
That, ultimately, is the White House’s hope. For it to materialize, a lot of things have to go right, starting with a favorable resolution of the upcoming spending battle. The optimistic scenario isn’t the most likely one: most forecasters, at the Federal Reserve and elsewhere, see a continuation of the steady grind since 2010. But a better than expected outcome can’t be wholly discounted. Ask Bill.
Official White House Photo by Pete Souza.
