How the “Cliff Deal” Was Done

As I argued in last week’s blog, this country is facing a life-threatening spending problem that has piled up a national debt exceeding the value of goods and services we produce annually. There is no painless way out of this mess. The American people’s addiction to government services will make it very difficult for self-serving politicians to ignore constituent whining, put their careers at risk, and do the right thing for the country not just their home districts and states. Since the core of the American addiction is entitlements it’s hard to be sanguine that this mess can be cleaned up before an economic Armageddon compels it.

Entitlement programs – Social Security, Medicare, Medicaid, Welfare and other entitlements – represent 62% of federal spending, programs. They have always been taken off the table in previous spending negotiations. Obviously no meaningful reduction in spending can happen without shrinking entitlements significantly. Add in defense spending (19%) and interest on the national debt (6%), and a total of 87% can’t be cut immediately or without shrieks and howls from citizens and their Washington representatives. Solutions exist, like privatizing all or part of Social Security, giving Medicare recipients greater choices and incentives to be wiser healthcare buyers, and allowing states more flexibility to manage Medicaid delivery. But these programs have strong advocates who are curiously less concerned with their unsustainability in the long term than with continuing them in their original and outdated incarnations.

Couple the impending entitlement spending train wreck with Obama’s my-way-or-the-highway negotiating style and it’s hard to see how the current congressional make-up and White House could agree on anything regardless of the consequences. The art of political negotiation must involve some degree of compromise so that a win/win outcome is possible even if neither side is particularly happy with it. In Obama’s world, only he is allowed to win. A Wall Street Journal op-ed this week summarized its writer’s interview with Speaker Boehner after the cliff deal was inked sans spending cuts. Boehner revealed that during his negotiations with Obama, at one point Boehner made an $800 billion new tax concession and asked Obama, "What am I getting?" Obama responded, "You don't get anything for it. I'm taking that anyway."

While negotiations were going on between Boehner and White House aides, Obama relentlessly demagogued Republicans in his speeches. He mocked their proposals for spending cuts, asserting that the country had no spending problem, as Republicans claimed, and that they were just trying to protect their rich friends from higher taxes. Boehner told Obama that “… we have a very serious spending problem,” to which Obama replied, "I'm getting tired of hearing you say that." Aside from his abrasive negotiating style, by denying that a spending problem exists, the man apparently believes in an alternate universe.

Obama’s remarkable lack of conciliation has won him no friends among Republican Senators and Representatives who see him as a partisan extremist. This is going to make any agreement in resolving our fiscal crisis almost impossible as long as he occupies the White House.

At some point during their Christmas negotiations it became apparent to Boehner that he couldn’t make a deal with Obama. The Maximum Leader’s round trip back from Hawaii cost taxpayers $3 million and all he contributed to the negotiations was to say “no” to every Boehner proposal. In hindsight everyone would have been better off if he’d stayed in Hawaii and had the final cliff deal FedEx’d for his signature. Negotiations with the White House were broken off when it became apparent that there would be no spending cuts.

Negotiating with Senate Majority Leader Reid wasn’t much different. As the clock wound down and the cliff approached, Boehner made repeated offers to Reid who, instead of responding promptly as the urgency of the situation demanded, often took 24 hours before sending a counter offer. Finally, Reid’s aides called Boehner’s aides to tell them Reid would not be sending a counter offer. Reid seemed to work harder at poisoning their relationship than reaching an agreement. After learning that Reid had given a Senate speech in which he called Boehner a dictator and other uncomplimentary terms, the Speaker became so frustrated that the next time he saw Reid at a White House meeting he told him to “go f--- yourself.”

Only when Minority Leader McConnell became concerned that going over the cliff could roil the US economy, if not the world’s, did he decide to contact Joe Biden directly and ask if he wanted to do a deal. The two veteran negotiators were able to hammer out an agreement in one day. The baby was ugly but McConnell was able to get all but eight Senate Republicans to vote for it. Reid sent the Senate bill to Boehner with a note that the House could make no changes to it. Most of the House Republicans balked at Reid’s take-it-or-leave-it decree and its absence of spending cuts. Only 85 Republicans voted for the Senate-crafted bill and were joined by 172 Democrats. The majority of Republicans – 150 of them – voted against the bill joined by 16 Democrats. Ryan and Boehner voted for the bill. House Majority Leader Eric Cantor voted against it. Over on the Senate side Marco Rubio voted against the bill setting up an interesting conflict between Ryan and Rubio – two likely Republican presidential contenders in 2016.

The House vote occurred two days before Boehner would stand for reelection as Speaker. His nominal opponent was Nancy Pelosi, but several Republicans were waiting in the wings to put their names forward if Boehner failed to get a first ballot win. He needed 214 votes, a simple majority, to win. He got 220 with 12 Republican defections for other candidates. It was originally thought that there would be 30 defections, which would have forced a second ballot. Pelosi got 192 votes. Boehner’s reelection was the closest first ballot win since Newt Gingrich’s close win in 1997 which followed his ethics wrist-slapping.

The passage of the “cliff” bill gave Obama bragging rights that he increased taxes on the rich. His original definition of “rich,” however, included couples making $250,000 or singles making $200,000. The deal that passed has thresholds for couples of $450,000 and $400,000 for singles. To that end, instead of increasing taxes on the “top 2%” as Obama had boasted his proposal would do, the deal he signed is in fact a tax increase on only the top 0.6%.

However, taxpayers will see their deductions capped beginning at the $250,000 and $200,000 thresholds which raise their effective tax rates. This stealth tax was accomplished by restoring the Personal Exemption Phase-out and the Pease provision, which expired in 2010. Obama resurrected it during negotiations for the tax increases. The personal exemption had been $3,800 per family member. Absent it, a married couple with two kids and a joint income above $250,000 will see an effective marginal tax increase of 4.4%. With four kids, that increases their marginal rate by 6%. Itemized deduction limitations add another 1% starting at the $200,000 and $250,000 thresholds.

Taxes on capital gains increased from 15% to 23.8% for individuals making more than $200,000 a year and couples earning more than $250,000, which includes the new 3.8% ObamaCare surtax on investment income. Capital gains haven’t been taxed this much since the first Clinton term. Taxes on dividends also increased from 15% to 23.8% for high earners, including the new 3.8% ObamaCare surtax on investment income.

Whereas Obama wanted an inheritance tax exemption of only $1 million, the exemption was increased to $5 million and indexed for inflation. However, the tax rate on inheritances above the exempted amount increased from 35% to 40%. Republicans wanted the inheritance tax – aka the “death tax” – eliminated. It is a hateful symbolic tax. Tax receipts from inheritance make up only a third of one percent of total tax receipts. People with potentially large estate tax liabilities avoid them through legal estate planning techniques so there is no economic argument for retaining the Estate Tax.

The Alternative Minimum Tax was created in 1969 because 155 high income households paid no income tax. At the time of its passage, the geniuses in Washington didn’t think to index it to inflation, thus in time this “class tax” became a “mass tax” as more middle class taxpayers were ensnared by it.  In recent years, Congress had to pass stop gap measures to set the threshold above middle class incomes. The cliff deal permanently patches the AMT and indexes it to inflation, rescuing 26 million taxpayers from it unless another temporary stop gap was passed this year. The AMT is the poster child for reforming the federal tax code.

The cliff deal didn’t extend the 2% payroll tax reduction that has been in place for the past two years. Therefore, despite Obama’s protestations that the middle class will not see tax increases, and that only the top 2% would see their taxes increased, the nonpartisan Tax Policy Center announced that 77% of taxpayers will be paying more taxes. Households earning between $40,000 and $50,000 will have an average tax increase of $580 and household incomes between $50,000 and $75,000 will average tax hikes of $820.

However, the cliff deal did extend unemployment benefits for another year, arguably reducing the incentive to aggressively look for work or accept a job whose pay is comparable to the unemployment benefit. Now, let me see if I’ve got this correct … we are going to reward unemployment and penalize employment (by increasing taxes 2%.)

Although it was not part of the cliff deal, the 2.3% medical device tax goes into effect this year. The rationale for ObamaCare was to bring down healthcare costs, but to pay for it medical devices are taxed, raising healthcare costs. By golly, I believe Obama really did discover an alternate universe!

Oh, and ObamaCare added 20 new taxes, so in combination with the “cliff taxes” 2013 should be an interesting year for the economy.

Negotiations over the debt ceiling, the deferred sequestration spending cuts, and getting a budget passed in the Senate loom in the near future. It’s hard to see how the Republicans can win any of these fights. Their leaders are inept if not cowardly. They can’t seem to muster the courage or competence to take their message to the people. If they fail to raise the debt ceiling and the government shuts down, they will get blamed, so why not get something for it – like budget passage by the Senate before agreeing to raise the ceiling? It ought to be easy to convince Americans that the country hasn’t had a budget since 2009 because Harry Reid won’t bring it to a vote, while the House Republicans have passed a budget every year since taking control.

Another tack would be to tie ceiling increases to entitlement reform – incrementally. The sequestration battle isn’t going to produce any sweeping spending cuts, certainly not in entitlements which are what must be reformed. Obama will just dig in his heels and let the automatic cuts occur as across the board cuts in domestic and defense spending, knowing that the Republicans will walk the plank to avoid defense cuts. So here’s the deal: conform Medicare eligibility to the Social Security retirement age which is 67 for people born after 1960 and Obama gets the equivalent of one month of spending in the debt ceiling increase. Raise the Social Security retirement age to 70 and the early retirement age from 62 to 67 over the next decade and he gets another month’s spending added to the debt ceiling. The price of another month is, for example, means-testing food stamps recipients, or block granting Medicaid to the states, or reducing unemployment benefits, or any of a long menu of quid pro quo spending reductions that get traded for offsetting incremental increases in the debt ceiling. Such a strategy is far more workable than haggling over sweeping spending reforms. It’s a message that can be taken to the people that they might understand: “We offered to raise the debt ceiling for X months’ worth of spending in return for Y and they turned us down.”

Obama will ask for more taxes in the coming negotiations. He saw Boehner’s near-death reelection, McConnell’s loss of eight in his caucus, and the almost two to one Republican vote against the McConnell-Biden bill. If he can continue getting the Republican leaders to buy into bad deals, he can divide and conquer their caucus and possibly regain the House majority in 2014. With Pelosi back in control, the last two years of his presidency would have smooth sailing as he completes his transformation of America into a welfare state.

Obama won Round One of the cliff deal. As he walked to Air Force One on New Year’s Day, he must have thought to himself, “Not a bad return for giving up a few days of my Hawaii vacation. And all I had to do was say ‘no’ repeatedly.”