Fiscal Cliff Deal Will Be the First of Many Republican Capitulations in 2013

You would have to have been living under a rock for the past 48 hours—or nursing an epic hangover—to have not heard of the bipartisan fiscal-cliff compromise that passed Congress on New Year’s Day. The law is called the "American Taxpayer Relief Act." It should have been called the "GOP Politician Relief Act," though, since it passed Congress because Congressional Republicans were afraid of being blamed for a fiscal cliff-mandated tax hike on most Americans. Republicans are comforting themselves by claiming that, in the next round of fiscal negotiations, they will have more leverage. But the opposite is true: Republicans will have even less leverage in future deals, and government will grow even larger as a result.

The deal cleans up a number of Congressional accounting gimmicks…

First, let’s review the fiscal cliff deal. The good news is that the law gets rid of a number of short-term accounting gimmicks by making permanent fixes to a broad swath of the federal tax code. The law permanently enshrines the Bush tax cuts for individual income taxes—which were, once upon a time, the bane of progressives’ existence—for individuals making less than $400,000.

Similarly, the law makes other permanent changes to the tax code. The alternative minimum tax, or AMT, will finally be permanently indexed to inflation: the largest tax-based discrepancy between the Congressional Budget Office’s long-term budget projections based on current law, and its more realistic "alternative scenario" in which Congress continues prior fiscal policies such as short-term fixes to the AMT.

Making these rates permanent, after years of temporary gimmickry, means that individuals and small businesses can finally plan their affairs, knowing what their tax rates will be for the near- to medium-term. Policy certainty, all else being equal, is a good thing.

…at a tremendous fiscal cost…

But this end to Congressional accounting gimmicks on the tax side comes with a price tag. Enshrining the Bush tax rates for individuals making less than $400,000 a year will increase the deficit by $762 billion over the next ten years. The permanent AMT fix will cost $1.8 trillion over the same time period. Overall, the tax provisions of the American Taxpayer Relief Act will increase the deficit by $3.9 trillion over ten years, relative to what would have happened had we jumped over the fiscal cliff.

And taxes are still going up. Taxes on capital gains and dividends will increase to a maximum rate of 20 percent. (Under the Bush tax cuts, capital gains and dividends were taxed at 15 percent; after their expiration, capital gains were to be taxed at 20 percent, and dividends at ordinary income tax rates as high as 39.6 percent.) Increasing capital-gains taxes by 33% will dramatically increase the cost, and the risk, of investing in the private sector.

In addition, of course, the law increases tax rates on those making more than $400,000, and phases out important tax exemptions for those making more than $250,000.

…with zero spending reform

The key driver of our persistent deficits is federal health-care spending. The law makes no serious attempt to reform health spending; it continues the annual "doc fix" Medicare accounting gimmickry, and does nothing to rein in the overall growth of Medicare, Medicaid, and Obamacare.

Relative to current policy, the fiscal cliff deal increases taxes by $620 billion over the next ten years, and reduces spending by $15 billion. That’s a ratio of 41 dollars in tax increases for every dollar of spending cuts. Remember August 2011, when eight Republican presidential candidates swore that they would walk away from a deal that would raise taxes by ten cents for every dollar of spending cuts?

That math is ancient history. What Republicans just helped shepherd through Congress involves a ratio of tax increases to spending cuts that is 413 times less favorable than the deal that those eight candidates considered to be insufficiently conservative. And it makes a mockery of President Obama’s oft-repeated claim to desire an approach to deficit reduction that is "balanced" between tax increases and spending cuts.

The deal increases the progressivity of our tax code, by increasing the share of the federal tax burden that will be paid by higher earners. But the United States already has the most progressive tax code in the OECD. Making the tax code even more progressive means that the broad swath of American voters will continue to be insulated from the cost of higher government spending, reducing the political appeal of future spending cuts.

The debt ceiling does not provide Republicans with ’leverage’

On the Sunday show circuit, GOP politicians like Sens. Bob Corker (Tenn.) and Lindsey Graham (S.C.) have been arguing that it’s okay for Republicans to capitulate on the fiscal cliff, because they’ll have "leverage" during the next set of fiscal negotiations, because the next round will involve raising the federal debt ceiling.

If Congress doesn’t raise the debt ceiling, the United States will be forced to default on some of its outstanding debt. Such an outcome would wreak havoc on financial markets, because U.S. treasury bonds play a critical, and very large, role in the global financial system. The stock market would crash. Interest rates on federal debt would skyrocket. The resultant economic chaos would make the fiscal cliff look like child’s play. And yet, we are to believe that a Republican party that was afraid of going over the fiscal cliff is totally fine with defaulting on the national debt?

The Republican calculation appears to be that President Obama will get equally blamed for a debt default. But this seems unlikely. After all, it’s Republicans, not Democrats, who are arguing that the debt limit gives them some sort of "leverage." It would have been unfair to blame Republicans if we had gone over the fiscal cliff; after all, Democrats are the ones who have opposed the Bush tax cuts all along. But in the case of the debt ceiling, if Republicans think they will escape blame for a default, they are delusional.

Ezra Klein is one of the few people who has figured this out. "Republicans make a big show of being unreasonable," he writes, "but they’re not nearly as crazy as the tea party would have you believe. 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…No one thinks that the White House wants to breach the debt ceiling."

In 1996, when President Clinton vetoed a set of fiscal reforms from the Newt Gingrich-led Republican Congress, the resultant government shutdown forced Republicans into a free-spending crouch for the remainder of their time in the majority. A debt default would be far more damaging to the economy than that government shutdown was, and would have more far-reaching political consequences.

They say that there’s no point in taking a hostage if you’re not willing to shoot the hostage. Hence, it is Republicans who will almost certainly capitulate in the 2013 debt-ceiling showdown. They’ll either do it to avoid default, or, even worse, they’ll do it after a default in which they are blamed for the turbulence that follows.

The GOP needs to reboot its fiscal strategy

For Republicans, the only way to avoid certain doom is to come up with an entirely new fiscal strategy. The latest word from House Speaker John Boehner’s office is encouraging in this regard. An aide to the Speaker told The Hill that Boehner will no longer negotiate with the President on fiscal deals. Instead, "he is recommitting himself and the House to what we’ve done, which is working through regular order and letting the House work its will."

This is a good start. The best way for Republicans to show that they are governing responsibly is by passing legislation in the House of Representatives, which they control, that reforms entitlements and reduces spending. In 2011, Boehner articulated a useful principle for future deficit reduction: that he would vote to raise the debt ceiling by only as much as any accompanying legislation reduced the deficit over a ten-year period.

In 2013, Boehner can use this principle to pass legislation that raises the debt ceiling in exchange for pragmatic entitlement reform, such as raising the Medicare retirement age and applying the chained-CPI inflation index to Social Security benefits. Instead of negotiating with President Obama, however, Boehner and Sen. Mitch McConnell (Ky.) should negotiate with centrist Senate Democrats and Vice-President Joe Biden, who has shown an impressive ability to get things done.

Only then—when a debt-ceiling bill gets through Congress—will Republicans have leverage with President Obama. It’s inconceivable that Obama would veto a bill that would prevent the government from defaulting on its debt. So Republicans had better start schmoozing with centrist Senate Democrats. Without them, one way or another, it will again be Republicans who fold in the fiscal fights of 2013.

This piece originally appeared in Forbes

This piece originally appeared in Forbes