Talking Them Down from the Cliff....Pt. 2

We will post the third part when the deal is finally concluded, at which time we will reckon the meaningful winners and losers…and those in Washington, too.


The public posturing by the President and his supporters on the one hand, and by the Congressional Republicans on the other hand, has moved little since the initial positions taken just after the election’s results became clear. If anything, the lines drawn in the sand for their positions on taxes, the key element of this phase of the negotiations, have been dug more deeply, which will make them harder to cross. Both sides also seem to be saying that President Obama and Speaker Boehner have not yet begun face-to-face negotiations: Obama is saying that they will begin when the Republicans agree to the tax increases on the most wealthy, while Boehner, who has agreed to revenue increases but not tax rate increases, is looking for the President to put “real spending cuts”—by which he means cuts to the cost of entitlement programs—on the table before meaningful negotiations can begin.

Despite the gap in public, and even the lack of any acknowledged behind-the-scenes direct negotiations, there is movement in some of the positions and even optimism about the outcome. So far, Wall Street and the markets show no sign of alarm.  It is by no means certain that any agreement will be reached by the end of the year, when the automatic end of tax cuts and beginning of sequestration begin, but there is no panic about that, because after that, the pressure to conclude a deal will rise sharply, and there is confidence on all sides that it will then get done.

The reckoning is that the President and the Democrats have most of the advantage:  Obama's election win is still fresh (and the margin has grown as the counting completes) and the fall-back costs of failure to agree are deemed greater for the Republicans.  The Tea Party Republicans may not feel the same way, though, as no agreement would mean the fastest reduction in the deficit, so if they get the upper hand with Boehner we could be in a stalemate next month which resembles the current National Hockey League lockout:  no agreement, no negotiations, continuing erosion of the brand (in this case, of the U.S. dollar).  As we pointed out in our previous post, Boehner needs to thread the needle in a deal which can convince 50-75 Republican Congressmen to come with him and not cause the other 160-180 ones to vote him out of his leadership position.  The key difference between 2011 and now is that the conservative Republicans (and their lobbyist godfather, Grover Norquist) seem to have authorized Boehner to go ahead and make a deal which they will not support, in the interests of avoiding a generalized tax increase for which they would suffer severe political consequences.

Dealing Out the New, New Cards

How then is the emerging deal shaping up?  This is where it gets very fuzzy, but some guesses may still be made.  The Speaker offered $800 billion in additional revenues over ten years; Obama's proposal was $1.6 trillion. Splitting the difference would be $1.2 trillion, and that's certainly a likely figure. It also is the amount that had been tentatively agreed by Obama and Boehner two years ago, before Boehner got his negotiating legs cut out from under him by his caucus.  Essentially, that would be Boehner's $800 billion in reduced "tax expenditures" plus Obama's $400 billion in tax rate increases for the wealthy. Somehow, this seems too easy;  I would guess instead the revenue increase number will be cut back to $1 trillion, with somewhat less than the above figures both in the tax rate increases and in the deductions eliminated.  This will allow both sides to claim a measure of victory, as it's always easier to get agreement on reducing tax increases than going the other way, and it will provide more room for phasing in tax increases gradually during this continuing period of vulnerability for the economy.

I'm looking for two gradations in the higher income rates, one for those with income over $1 million and one for $250K - $1 million; I'm looking for the proposed deduction cuts to be smoothed out to reduce the impact on moderate taxpayers, for a substantial shift in the income level when the infamous Alternative Minimum Tax begins to apply, and for tax rates on capital gains and dividends to be increased but to have a top rate lower than the marginal rate for the highest income ranges. The surprising thing is that both sides seem ready to throw the payroll tax reduction "holiday" of the past couple of years under the bus; this is surprising because the economy's recovery is still relatively weak, but the payroll tax cut is one that, by general agreement, can not be extended indefinitely (the money is needed to support the trust funds for Social Security and Medicare, which are shrinking); I thought it would be phased out over the next two years, but both sides seem to need to tote that money up for the promised savings they want to tout.

There will be a few hundred billion in cuts in discretionary expenses (Obama's Federal departments have been harvesting and storing them up for this purpose), and I'm looking for a couple hundred billion of new defense/security/intelligence cuts, as well (though not so much, or so blunt, as the sequestration cuts).  There were already some cuts achieved in previous negotiations; those will be counted in the total of the final agreement.  There will also be a very small amount of additional investments and aid to states in the final package, and some sort of agreement to fix the debt ceiling through 2014.  The package of specific deficit reductions that will be announced--and it will come together quickly once the progress starts, somewhere in the calendar range of Dec. 26-Jan. 15--will be a bit small, in the range of $2.5-3.0 trillion, but it will include, on top of that, an agreement to find more from the big entitlement programs and from closing loopholes in the tax code.  That amount will be small, but increasing, over the 10-year timeline that everyone has agreed to view, and will bring the total up to $4 trillion, enough--without including rapid economic growth into the calculations--to bring the deficit down but not eliminate it.

This will bring the second difficult aspect of this agreement, finding the formula that compels Congress and the President to accomplish this last trillion without specifying the details now.  The specifics will take months, possibly the entire session of Congress, to work out. I will be very surprised if there is any agreement about Medicare, Medicaid, or Social Security in either the lame-duck session or the initial months of the new Congress, and, to be frank, it would be unwise to try to revise the tax code in a hurry.  Still, the staff groups are able to put a number around reasonable savings that would result from the process, and that will be the final slide in the Power Point presentation--that, and the fiscal handcuffing that would result if the special bipartisan groups to be formed cannot reach a result.  I'm guessing it would be some sort of automatic additional increase in tax rates across the board, something everyone would seek to avoid.

I'm Entitled (to Spout Off, Anyway); How About You?

Now, to close, a few comments about the most knotty of all the problems, the question of what to do about the entitlements. 

Social Security is the one with the least urgent problem; essentially the challenge is to maintain a large-enough surplus in the trust fund so that the program will never be a burden on the national debt, which until now it has not.  The trust fund--which is a separate account from the overall Federal budget, but doesn't really have money stored away in Ft. Knox or anything--would begin to run an annual deficit in a few years, and if there are no changes, it would be depleted in 15 years or so, and after that full funding of it would begin to add to the deficit.  All that is needed is to change the trajectory a little, and we would get safely past the most difficult years of our demographic challenge, the ones when the ratio of workers to retirees is lowest, until about 2050, and then it would essentially be self-funding indefinitely into the future.  The pieties about holding the retirement age for Social Security are hypocritical; the resistance against reducing the cost of living adjustment (COLA) in it is not.  People think that the age 65 for retirement is inviolate, but they are wrong; this was already changed in the famous deal made in the Eighties by Reagan and Tip O'Neill.  It's gradually increasing, to 67 for full benefits (of course, one can retire earlier and get less); it could be adjusted a bit more over the next decade or two, and we'd be home free.  The COLA is seductively attractive, in that it saves a ton of money over the long term, but that also means that the value of the benefit would be shrinking, and it's already very low.

Medicare is the largest problem in numerical terms, and in the sense that the current trajectory is going to bankrupt the program soonest.  The Affordable Care Act, the infamous Obamacare of political demagoguery of all sides, has had a significant effect improving the finances of the program, but not nearly enough. The remedies which are usually proposed--increasing the age of eligibility, or reducing the benefits (the latter, in the wolf in sheep's clothing form of the Paul Ryan-proposed voucher program)--are the wrong ones.  Reducing benefits--any way that you do it--means bankrupting more seniors; increasing the eligibility age actually just makes the economic dynamics worse.  The best solution is actually the opposite:  lowering the eligibility age, making it available to people 55 and older!  Because their health costs are lower than older folks, bringing them into the program would improve the economics of the program.  If we think of it as a business, raising the eligibility age focuses the program more on the unprofitable customers, expanding it brings in more profitable customers, improving the operating leverage.  Of course, there would be no requirement for fifty-something-ers to buy in, but some would do so (those getting the worst deal from the private insurers), and employers would find it attractive to participate for their older employees (something which should be allowed through the reform).  Instead of creating a death spiral for Medicare, expanding would create a virtuous cycle which, combined with changing it from fee-for-services to fee-for-customers, focusing on prevention and maintenance, could end up making the whole thing workable in the long run--and eliminating decades more of debates about whether the health insurance industry needs the challenge of "the public option", which otherwise is not going to go away.

I actually think Medicaid is the most difficult problem of the three to solve.  Mostly Medicaid is about the assistance to states to provide for health services for those who can not afford health insurance, so its viability is challenged both by the dire state of the states' budgets and the rising costs of health.  Already, many states are cutting their rolls of eligible people by fiat; soon, the horror stories will begin to pile up in those states.  It's going to get worse, and some kind of Federal program to improve minimum standards for states will be worthless unless it is accompanied by an increase in funding--and the pressure will all be in the other direction. I have no proposed solution for the present, except that we must insist on holding the line against cuts and holding states responsible for the health of their poorest and the effectiveness of how the money is spent. Eventually, once other problems get addressed (Federal deficits, state revenues, the economy, health costs), we will come back to this one, and hopefully there will not be too great a cost in the meantime.