Obama’s Fiscal Cliff and Its Consequence

Last year Congress and Obama were unable to reach an agreement that suited Obama’s sense of “fairness” on the debt ceiling – i.e. getting the rich to pay more taxes in return for cutting spending. When, after agreeing to the amount of tax increase, Obama changed his mind, the can got kicked down the road.

Recall that Obama had agreed to hundreds of billions of dollars in cuts to Medicare and Medicaid entitlement spending in return for $800 billion in additional taxes – concessions ideologically painful to both parties. Then when Congressional Democrats had a hissy fit because they weren’t invited to the negotiations so they could stonewall them, Obama panicked and told Boehner he had to have $1.2 trillion in tax increases. Boehner accused Obama of “moving the goal posts” and walked out – rightfully so.

Each side postured for its base but the country’s bills had to be paid. The Grand Bargain of 2011 was the step-child born to the Republican and Democrat agreement to keep the country out of bankruptcy court by creating automatic tax increases and spending cuts designed to force Congress and the White House to negotiate a more sensible resolution before December 31, 2012 … or else. The child’s name was Sequestration, a strange appellation. Juries are sequestered to isolate them from news about their case, property is sequestered to settle a debt, sometimes people with a disease are sequestered in the interest of the public health. What got sequestered in last summer’s negotiations? Nerve apparently. Obama thinks that as President he has the last word in governing the US. Kings and emperors may have that power but not presidents of republics. Rather than make Obama drink from the well he poisoned, Boehner lost his nerve and agreed to postpone the problem rather than solving it. Cowardice would have been a better name for this step-child.

We have to go back to 1985 to understand how this strange word entered the legislative lexicon. That year the Gramm-Rudman-Hollings Deficit Reduction Act (yes, they were trying to reduce the deficit back then too) introduced the concept and term “sequestration” to deal with the fact that the sum of the spending bills passed by Congress would often exceed the aggregate budget approved by Congress. Theoretically, the excess would be sequestered by lopping off a percentage of each spending bill equal to the percentage by which their total exceeded the budget. What Messrs. Gramm, Rudman, and Hollings ignored, of course, was human nature. Or perhaps I should call it “congressional nature” so as not to give humans a bad name. Both houses of Congress have always been expected to bring home the bacon. After all, wasn’t that why they were elected? And if they failed in that appointed task, their high-minded derrieres would be sent packing home and replaced by a more effective bacon-bringer. So it shouldn’t shock you, dear reader, to learn that sequestration has never been used – until last November.

So, in the spirit of sequestration, Congress and the President must solve the problem they should have solved last year … except. Except now that His Majesty has been reelected, he is filled with renewed self-importance and has upped the ante to $1.6 trillion in tax increases – twice what he and Boehner originally agreed to. Except now a lame duck Congress has less than six weeks to deal with a problem that should be given six months to solve. Except now a Frankenstein monster will surely be created.

We’ve now come to the “or else” – a place some liken to a “fiscal cliff” to heighten the sense of high drama. Because Congress and Obama could not resolve their differences by selectively agreeing to spending cuts, the intelligent alternative was to take a meat-axe approach and lop off $1.2 trillion for the decade ending 2021. In 2013, that means a $55 billion cut in defense and a $55 billion cut in non-defense spending. The way the cuts are designed to work program spending will be reduced by $984 billion and the rest will come from reductions in debt service.

Of course the meat-axe approach assumes a sequestration spending solution will occur rather than a negotiated one.

On the revenue side, barring a negotiated solution, the tax increases of ObamaCare will become effective on January 1 and the Bush tax cuts expire. Those taxes will hit the wealthy and the middle class since the Bush tax cut favored both. Those with incomes of between $500,000 and $1 million will see their tax bills increase by about $40,000 – a fact that will affect their spending and investing, although not likely for the good of the economy.  The top two income tax rates will jump by nearly 20%, with the top rate going from 35% to almost 40%. Employer payroll tax increases from 37.4% to 52.2% – almost guaranteeing a recession. For investors, the capital gains tax rate will almost double from 15% to 28% and taxes on dividends will almost triple from 15% to almost 40%. That will negatively impact trading volumes and pricing, and people who live off of dividends will have to live on less. Then there’s the bad old estate tax that allows zillionaires to pass their ill-gotten gains to their worthless, leisure-class offspring. The $5.12 million exemption from estate tax will shrink to $1 million and the tax will go from zero (the 2010 rate) to 55%, and portability will vanish.

As long as we’re on the estate tax, wanna’ guess how much it raises annually? Until the recent Bush tax cuts, the historic estate annual estate tax receipts averaged about $20 billion – a pittance in receipts among the nearly $3 trillion the government receives in total.  In October, the Obama’s government spent $150 billion more than it brought in as tax receipts. That means the entire income from average estate taxes would have paid for four days of government profligacy during 2012.

But the estate tax serves as a highly symbolic reminder that the government boot is on the neck of free Americans, since estates consist of money that has already been taxed once. The government wants more than half of our already-taxed estate value anyway.  Thus, when we die and if our estate exceeds the now-reduced $1 million exemption, the government jack-boot is a reminder that everything belongs to the government.

Most middle class families don’t realize how little $1 million is relative to a lifetime accumulation of assets. I learned it when I sold the house of my blue-collar, depression-era parents and liquidated their savings and investments which I’d helped them manage, terrified as they were that they would run out of money before death. Anyone who thinks the truly rich, with their tax accountants and lawyers, pay estate taxes … well, I still have the Golden Gate Bridge I’m trying to sell.

Notwithstanding his protestations that he is after the “rich” people and that his tax increase will not be felt by “97% of all small businesses,” Obama is apparently ignorant that the top 3% of small businesses earn 91% of the total small business income and employ 54% of the private US workforce. The estate tax is the meanest of all taxes. It raises almost no tax receipts and unfairly impacts intergenerational transfers of farms and businesses rather than money assets. Everyone should hope someday to pass an estate to their children, and in a healthy economy home values and 401k savings would exceed the current exemption.

Pundits and debt-watchers have shown that the revenue side of last fall’s non-agreement could be achieved by limiting deductions on the wealthiest income earners, but Obama is committed to ideology more than common sense by insisting that taxes on the rich must increase even when it’s been shown historically that increasing tax rates do not increase tax revenue by the amount expected. Even a dumb animal will eventually learn by trying and failing. Politicians take longer.

To wit:

None of the increased taxes on personal income tax and capital gains have brought in the expected receipts to the US Treasury in the years following World War II.  For almost seven decades, tax revenue as a percentage of GDP has averaged just under 19% regardless of the tax rate, which has been as high as 92% and as low as 28%. This observed phenomenon, often referred to as Hauser’s Law, reflects the fact that people change their behavior when taxed. High taxes encourage them to shift, hide, under-report, and defer income to keep government out of their pockets. The more tax dollars that are at risk of taxes, the more expertise will be hired to conserve it. For all of his sanctimonious rants about not paying enough taxes, you can bet your bloomers that Warren Buffett pays a small army of accountants and tax lawyers to keep his IRS check low. Otherwise he would voluntarily contribute money to the US Treasury rather than be compelled by law to pay it.

Filled with his reelected righteousness, Obama has demanded $1.6 trillion in tax receipts over the next ten years from the so-called “rich” – i.e. those who make over $250,000 per couple annually. He’ll never see it happen. While he is able to seriously damage the economy in the coming decade, even if he could get the amount he wants from taxes, it would cover just 16% of the combined deficits that will really happen. ObamaCare will increase federal spending over $2 trillion and he wants to spend an additional $2.5 trillion in the decade. Unfortunately, there’s not enough gold in the goose to solve the deficit problem, but the breeders of class envy will be able to take solace that the so-called “rich” fat cats have less money even as America still has the deficit caused by the government fat cats.

Whether or not it happens before December 31, at some point Congress and Obama will have to choose between the meat-axe spending reductions of sequestration or negotiation, and at that time the negotiation will modify the tax increases of sequestration. When it comes to cuts in government spending, the smoke and mirrors display will be in full splendor as the Obama, Pelosi, Reid axis squabble with Republicans over the definition of a “cut.” Already the Democrats are jockeying to define a “cut” as a reduction in the spending baseline. In other words, something on which spending was planned but not appropriated is a “cut.” That’s like saying someone “saved” money by buying something for less than its sticker price. Whatever should have been spent is irrelevant to what is spent. Obama’s budget already includes a spending reduction due to the wind-down of the Iraq and Afghan wars, which happened for political reasons, not spending reductions. But Obama wants to count that as a spending cut.

Other smoke and mirror tricks are in his budget. Prior budgets that never got past Congress included $10 billion for a program, which will get cut 20% for a $2 billion saving. It doesn’t take a genius to figure out that spending cuts mean reductions in what has been spent and will continue to be spent unless cut. And that means entitlements, the sacred territory of the Left. There is no way to reduce spending without some constituency giving up something, which is what makes negotiations tough. And even if not one new program occurs this century, federal spending will eat up 46% of GDP by mid-century – twice its current bite which is 7% above historic levels – unless spending is C-U-T.

Can Congress be trusted to cut? Both Reagan and Bush 41 learned hard lessons by trusting that increased taxes would be followed by agreed upon spending cuts.

In 1982, Reagan agreed to a tax increase with a promised $3 in spending cuts for every $1 in tax hikes. When he left office, tax receipts had increased $290 billion and spending had increased $318 billion, producing a larger deficit than the one the “promise” was to correct. His memoirs recalled that the Democrats reneged on their spending cut promise.  Shocking!

In 1990, Bush 41 broke his famous “read my lips, no new taxes” pledge, agreeing to a $1 tax increase for $2 in spending cuts. Tax receipts grew by $60 billion and spending increased by $128 billion. Infuriated Republicans, miffed by his broken pledge and trust of Congress, sat out the 1992 election and Bush lost to Clinton.

One hopes Boehner will remember these experiences when the taxing and spending negotiations are underway and insist that spending cuts be enacted before tax increases become law.

Notwithstanding the sober reminders of failed historic negotiations and agreements, the Republicans will feel the pressure to make a deal, because they are convinced they’ll be blamed for “cliff diving.” Obama will therefore play them like a fiddle.

Recent surveys by Rasmussen and others have shown a majority of Americans believe the Bush tax cuts should expire for the wealthiest Americans, but a majority of those surveyed said that if the “fiscal cliff” is not avoided it will be the Republicans’ fault.  All Obama has to do is let the sequestration happen, cutting defense and domestic program spending and raising taxes on the middle class. If he holds fast to the inflexible position he has staked out in his tax increase demand, negotiations will likely collapse. Obama will blame the Republicans because they wouldn’t agree to his “reasonable” tax increases. With the middle class screaming about their taxes being increased, the Democrats will propose a bill to lower taxes on the middle class and dare the Republicans to vote against it. When they cave, Obama will have his increase on the wealthy without giving anything on spending and the Republicans will have lost their bargaining chips. Democrats will agree to some spending cuts as a political expedient, but the cuts will be a lot less than they would have been otherwise.

Democrats like Senator Patty Murray have already proposed letting negotiations go over the cliff. On a recent Sunday talk show she said, “We will reach a point at the end of this year where all the tax cuts expire, and we will start over next year and whatever we do will be a tax cut for whatever package we put together. That may be the way to get past this.” Howard Dean wants large tax increases and big defense spending cuts, and he has said he is willing to go over the cliff and even risk a recession to protect entitlement programs.

Republicans have rarely demonstrated political skill, but they could and should make the compelling argument that a lame duck Congress is not the right legislature to be negotiating a resolution to this badly-timed fiscal cliff. The 2012 election sent a new Congress to Washington to solve problems this far-reaching. Voters ought to see the wisdom in passing minimal legislation to keep the government running while a new Congress takes hold of the reins.

Boehner will be on solid Constitutional grounds by arguing against a lame duck solution because the 20^th Amendment shortened the original interval established by the Founders between the election of a new government and its installation. Its purpose was to prevent lame duck law-making. The new congressional term starts January 3, whereas the new executive term doesn’t start until January 20.

In fact, the new Congress will have something this Congress no longer has – two more years before any of them face the voters.  If Democrats block passing this issue to the incoming Congress, there is no reason why the sequestration tax increases and spending cuts should become permanent. Republicans should argue that no one wants the sequestration-imposed solution, and if the December 31 deadline passes without a permanent solution, a negotiated solution will be superior no matter how long it takes to get it.

A bad deal is worse than delaying the fiscal cliff and it’s worse than going over the fiscal cliff. Even weak-willed, wobbly-spined John Boehner ought to be able to make the case that a new Congress which has skin in the game and must face the voters in two years should be the choice of 2012 voters to negotiate with Obama.

If he can’t make that argument successfully, Boehner should resign as Speaker.