Battle Lines Form around Fiscal Cliff

Possible solution could include tax reform and changes to entitlement programs.

Milton Ezrati of Lord AbbettBattle lines have begun to form around the fiscal cliff. They will, of course, shift and waver in coming weeks. That is the nature of negotiations. In the process, financial markets will alternately suffer bouts of fear and relief. In all likelihood, the give-and-take will go on until the last possible minute. That, too, is the nature of such negotiations. But for all the doubts that will occur in the interim, it’s likely that in the end, the talks and maneuvers will keep the nation from going off the cliff. The exact nature of coming compromises remains vague, but the positioning to date gives at least a hint.

The feeling at the moment is that the Democrats have the advantage. The election, after all, put President Obama back into the White House, modestly enlarged the party’s Senate majority and gave Democrats small gains in the House of Representatives. But Republicans retain a solid majority in the House and have the ability to block legislation in the Senate. Especially since there is dissension within the two parties, neither side has the power to impose its will on the other. What is more, both sides face tremendous pressure to compromise. If each party hopes that the public would blame the other for failure, the prospect of a recession, which would almost certainly accompany a fall off the cliff, simply carries too much risk for most politicians. Even such tough partisans as Senate Majority Leader Harry Reid, D-Nev., and House Minority Leader Nancy Pelosi, D-Calif., have bowed to the imperatives of the moment and begun to talk in terms of “grand bargains” and “compromise.” Pelosi says bluntly, “We want agreement,” while Reid decries “brinkmanship.”

Right now, the president offers the biggest impediment to the reform solution. Though he has embraced such reform principles in the past, he wants first to impose higher tax rates on wealthier Americans and then negotiate reform from those higher rates. For this reason Obama has argued that eliminating or capping deductions would fail to provide sufficient revenue. “The math,” he says, “tends not to work.” But analysts on both sides of the political spectrum say the government could generate considerable revenue in this way. Those analyses have had an effect. Many, even within the president’s own party, seem reluctant to risk failure for the sake of the administration’s two-step process. A centrist group called the New Democratic Coalition has formed that includes at least one-quarter of the Democratic caucus, and it has made clear that it wants to embrace the new Republican openness to revenue increases within a reform effort. Combined with the 15 remaining conservative Democrats, the so-called “Blue Dogs,” mostly from Southern states, this new coalition could add considerable force for compromise.

Similarly, the pressure of the cliff seems to have made Congress more open to entitlement reform. Republicans, of course, built part of their presidential campaign around it. Now, while the Democratic left still rejects entitlement reform out of hand, the pressures of the moment have raised other voices within the party. Some would only permit minor adjustments, but others, led by Senator Dick Durbin of Illinois, would consider bolder ways to contain entitlement spending. Bolstered by work done at the left-leaning Center for American Progress, the new Democrat positions focus on raising the eligibility age for Medicare, introducing means testing for benefits and competitive bidding for some services, and seeking savings by replacing the fee-for-service system with payments for medical outcomes. Even Obama has tipped his hat to such proposals, though only in a general way. They are far from Republican positions, but no less a partisan than Senate Minority Leader Mitch McConnell, R-Ky., has characterized them as a basis for compromise.

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About the Author

Milton Ezrati

Milton Ezrati

Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. His latest book, Thirty Tomorrows, linking aging demographics and globalization, will appear next summer from Thomas Dunne Books of St. Martin’s Press. See more of his articles about the economy here.

 

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