Odds of tumbling over fiscal cliff are rising (Updated)

Image credit: Gage Skidmore (Flickr) (CC BY-SA 2.0)

Image credit: Gage Skidmore (Flickr) (CC BY-SA 2.0)

The chance of going over the cliff has probably risen a bit to 25 percent over the last two weeks because some high level tacticians in both parties have suggested that “cliff-diving” may actually be advantageous for Republicans/Democrats with respect to their ultimate goal.

Some Democratic tacticians suggest that going over the cliff “solves” the deficit problem by way of huge tax increases and sizable spending cuts – including cuts on defense – while the President can successfully saddle Republicans with the blame for the nasty recession that follows.  Such a strategy might be too cute as Presidents usually get blamed for recessions on their watch. That said, Obama doesn’t have to stand for re-election, though some, perhaps nervous, Democrats in Congress face elections in 22 months.

Republican tacticians who favor going over the cliff think the President/Democrats can be saddled with the blame and that Republicans can “fix” the problem next year with tax rate cuts and loophole-closing (tax reform) for what will by then be a grateful electorate looking for a way out of recession cause by tax increases that follow from going over the cliff. Again, probably too cute. Some add that the March 2013 “debt ceiling” will provide Republicans with leverage to get what they want – lower tax rates – in a troubled post-cliff environment.

Still, the base case, with a 75 percent chance, is a last minute “down payment” on deficit reduction composed of a modest tax rate increase – say to 37 percent on the “rich” – and some modest entitlement reform perhaps including a promise to consider raising the Medicare eligibility age over time from 65 to 67.  Tax rates on capital gains and dividends may be raised, say to 20 percent (actually to 23.8 percent, given the Medicare tax that takes effect January 1). The rest of the cliff problem will be put on hold by way of “extenders” that freeze current law until, perhaps, June 30, 2013.

The base case, with the freeze,  leaves markets without clear direction on tax rates and sequester spending, pretty much where they are now. That said, relief from not going over the cliff might precipitate a year-end or early January rally in “risk on” assets.

The “debt ceiling” – no more federal borrowing without a vote by the Congress to approve – is dangerous. Technically, we reach the ceiling by about year-end but the Treasury can use its usual tricks to delay running out of money to pay its bills until late Feb/early March. Republicans, smarting from the President’s successful push to raise tax rates on the rich above the 3.8 percent increase already included in the Medicare tax for Medicare may decide the hold out for concessions/rollbacks as a condition for raising the debt ceiling. That said, House Speaker Boehner does not want to repeat the debt ceiling fiasco of mid-2011 and probably can get enough Republican and Democratic votes to pass a debt ceiling increase in the Republican-controlled House. Democrats, of course, control the Senate.

Overall, by mid-2013, Washington will probably have effected some modest deficit reduction with perhaps a little over a trillion dollars in cuts over the next decade. Stabilizing the debt-to-GDP ratio will require at least $4 trillion in cuts and 3 percent growth, so the debt-to-GDP ratio will still be on track to rise steadily but a little more slowly. Congress will try to put plenty of lipstick on this “pig of a deal” and get back to politics as usual until a real crisis arises in the form of higher borrowing costs that sharply boost the deficit ($160 billion for each percentage point rise above the current tiny average borrowing cost of 0.5 percent) and slow growth.

In sum, don’t expect Congress to undertake major preemptive deficit reduction. It will move in response to a real crisis that will, if history and the experience of other mega-borrowers like Japan is any guide, be slow to come.

Most unfortunate.

2 thoughts on “Odds of tumbling over fiscal cliff are rising (Updated)

  1. I see that the GOP, once again, does not believe the polls over whether Obama got blame for the recession or whether he’ll get the blame for sticking to his current proposal.

    these guys live in la la land. Even after the election they act like nothing has changed.

  2. “Whether Obama got blame..”? Beside the remedial grammar, what does that mean?
    La la land is for those who see ever shifting polls as the main compass for strategy, and think that going along with policies anathema to our organizing and defining principles and to common sense — policies of destruction to our economy and constitution — will somehow be good and sustainable to the party. Voter confusion is due in part to their confusion and cynicism from the GOP doing this in the past.

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