The Politics of Taxes…Over a Barrel, Heading for the Cliff

November 2, 2012

With Election Day just a few days away, it is hard to believe that both President Barack Obama and Governor Mitt Romney do, in fact, agree on a handful of major policy issues despite the deluge of television advertisements and campaign speeches arguing to the contrary. The United States is facing serious economic decisions on the horizon – the fiscal cliff of looming deep federal budget cuts, wide-ranging tax increases, the debt ceiling (again) slowing economic growth.

Both Obama and Romney support in principle cutting corporate taxes, ensuring middle class tax cuts do not expire and working to cut the deficit. However, even after all of the ballots have been cast and counted and we have a new president, it remains to be seen whether an agreement can be reached quickly to ensure that the United States avoids going over that steep economic cliff.

After Nov. 6, the new parlor game in Washington will zero in on how to prevent the proverbial barrel going over Niagara Falls. Washington will be inundated with intense jockeying by policymakers and lobbying by stakeholders over protecting key priorities from deep spending cuts (defense, Medicare, etc.) and whether to allow tax cuts for the upper brackets to expire.

At the end of the day, a deal will likely be struck, it is just a question of what exactly will happen between Nov. 7 and Jan. 20, if anything. But there are certain things that will have to happen.

Whether to extend the Bush-era tax cuts or not.

Obama and Democratic lawmakers only want to extend them for middle class individuals and not those earning more than $250,000. Republicans counter that small business owners, seen as a job growth engine, would suffer because they are lumped in that upper category. Some Democrats in Congress have suggested extending the tax cuts to those earning up to $1 million to address the concerns about small businesses. Obama wants to limit any extension of the Bush tax cuts to middle and lower income earners, increase the capital gains tax for high income earners.

Romney wants to keep most of the Bush tax breaks and lower them by another 20 percent. He also has pushed to limit deductions for high-income earners and, at the same time, eliminate the estate tax. Both candidates want to repeal the Alternative Minimum Tax. As part of any deal, policymakers could try to “go big” by including reform to the corporate tax code, roughly 35 percent today. Obama has backed cutting it to 28 percent and Romney has advocated 25 percent. The big question on that issue is how to offset some of it by reducing other corporate tax breaks.

Looming budget cuts known as sequestration.

Congress and Obama cut a deal in 2011 that put in place limits on federal spending with the goal of cutting $1.2 trillion over a decade, including from defense and discretionary programs. The concept was that the automatic cuts – despised by both Democrats and Republicans – would force policymakers to find other ways to cut spending and/or raise revenue.

So far, that has not happened, though efforts are still continuing. For 2013, that total is about $109 billion in automatic cuts, roughly 3 percent of the overall $3.6 trillion federal budget and about 8 percent of the deficit. While seemingly small potatoes, it adds up quickly and the Congressional Budget Office has warned that the spending cuts, coupled with tax hikes, could pull $600 billion out of the U.S. economy.

Work has already begun relatively quietly by a bipartisan group of senators who are trying to find a way to avoid the fiscal cliff. Some congressional aides have told reporters that one option would be to replace the automatic cuts with other spending cuts and raising additional revenues (e.g. taxes). Many of the specific details are being closely held. Obama said at the last debate he did not expect the automatic cuts to happen but has not elaborated on how to avoid it. Romney has denounced the sequestration but also has not elaborated.

What will likely happen:

  • If Obama is re-elected, he will likely seek to claim a mandate from voters and Congress will probably have to accede to some of his requests, including raising capital gains taxes, estate taxes and closing other tax loopholes. It will almost certainly mean taxes for the upper income tax brackets will go up and there could be some compromises on spending cuts that avoids hitting the defense industry too hard.  He has offered to cut $2.50 in spending for every $1 in new tax revenue. That would represent a modified Simpson-Bowles proposal that was floated a couple of years ago and suggested a 3-1 ratio.
  • If Romney is elected, one possibility is that lawmakers pass legislation that extends the current tax cuts and puts off any major budget cuts until he is inaugurated and can negotiate his own deal with Congress. Such a move would keep the Bush tax cuts for some months longer. The unanswered question is whether Obama would sign legislation that extends the current picture or allow the Bush tax cuts – all of them – to expire at the end of the year as scheduled. However, that would likely be a significant risk to his legacy, especially if the economy plummets as a result.

There are additional pressure points on top of taxes and the fiscal cliff: the weak economic growth picture, most recently gauged at 2 percent for the third quarter of calendar 2012; a mixed unemployment picture with the rate at 7.8 percent; and the fact that the U.S. government again is creeping up to its debt borrowing limit. One report suggested that the government could hit the debt limit in the spring and the United States may not be so lucky on getting a debt downgrade a second time around if policymakers fail to raise the limit.

One thing that Wall Street and Main Street want is certainty. That was exemplified recently by the full-page advertisement from a group of 80-plus chief executives and business leaders calling for action by Washington. They are fully willing to accept a package in which the tax base is broadened but at the same time lowers the overall rates with the goal of raising revenue and cuts the deficit.

At the end of the day, it comes back to a basic principle – will policymakers be leaders and try to solve these problems they were elected to deal with or will they engage in the same politics of mutual assured destruction by just kicking the can further down the road as the economy continues to hobble along. All signs would suggest that the latter option is no option at all. Hang on for the ride, about the only we know is that it will not likely be smooth.

Jeremy Pelofsky is vice president for media strategy in Ketchum’s Public and Corporate Affairs practice. He joined after 15 years of experience working as a wire service correspondent for Reuters News and Bloomberg News in Washington, DC. He has covered the gamut of issues and beats, including the White House, the U.S. Congress, regulatory agencies as well as corporate and financial matters, political campaigns and legal issues. Jeremy also played leadership roles during his tenure at Reuters, serving for four years as the deputy editor for the Washington team of correspondents that covered company-related issues and agencies as well as launching Reuters’ 2008 political blog: Tales from the Trail.