The Exchange

Connelly: The Countdown to the Fiscal Cliff Has Begun

The Exchange

By Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University

Once the Presidential and Congressional elections are over, or even before, attention will focus anew on the "fiscal cliff" — the forced sequestration of both military and discretionary spending coupled with the expiration of all the Bush income and Obama payroll tax cuts.

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Congress agreed to this "solution" to our chronic debt and deficit problem — with elements thought ultimately unacceptable to both political parties — when they could not reach any other consensus. The view was that the outcome would be so bad neither party could live with the consequences politically, and a real (and more realistic) compromise agreement would thus be forced.

What's Coming?

The predicted consequences of the fiscal cliff indeed are odious. The severity of the spending cuts coupled with across the board tax increases virtually guarantees a renewed recession in 2013; the military cuts would be a disaster in the words of the Secretary of Defense; the social "safety net" would be shredded; unemployment would rapidly increase as economic activity contracts — the monthly job creation figures would quickly go negative.

And yet — barely two months before all this comes to pass, nothing is being done to move an agreement forward in Congress, except some preliminary posturing. Republicans continue to resist any deal that would eliminate the Bush tax cuts for upper-income earners including the top 3% of small businesses. Many Republicans up for re-election have signed the "Norquist pledge" to reject any "tax increase," which would preclude any such compromise.

Meanwhile, the White House has let it be known that President Obama (presumably, whether or not he is re-elected) would veto any package replacing the fiscal cliff that did not eliminate the Bush tax cuts for families and small businesses that earned over $250,000). While the Vice President mentioned a million dollar cap in his debate with Congressman Ryan, that appears to have been a trial balloon rather than a mature offer-in-compromise.

It's About Taxes

While both parties have until recently been relatively quiet about the expiration of the "temporary" cut in employees' portion of the payroll tax, some democrats have put that "tax increase' back on the table (if only to potentially embarrass Tea Party stalwarts who would be voting for a "tax increase" as part of any deal to let that stimulus expire as planned.

There are multiple alternative ways to replace the automatic spending cuts with more palatable reductions in spending programs — many were already in print during the discussions of the futile "Grand Bargain" between Speaker Boehner and President Obama in 2010, as well in the considerations of the "Super-Committee" in Congress that failed to reach agreement, resulting in the fiscal cliff. When the leadership finally goes back to the "drawing board", they will find plenty of options available for expense reductions that both parties have agreed to at one time or another in the past.

The big deal issue, therefore, really boils down to the tax issue.

And, unfortunately, there may be only one way around it to an agreement — but it is a route which would require that the fiscal cliff actually be triggered before it can be untangled!

Room for Compromise?

The reason for that would seem to be the "Norquist pledge" that prohibits most Republicans in Congress from voting for anything that smacks of a "tax increase" — so any deal with a penny of increase in any dimension is doomed to fail in the "lame duck" session of Congress after the election.

On the other hand, however, if the Bush Tax cuts all expire as a result of the fiscal cliff, then any agreed reassessment of that in the form of legislation would involve only tax increases, not decreases. This would free the Republican signers of the Norquist pledge to vote for a deal that otherwise meets their political objectives and that erases the effects of the fiscal cliff. In effect, we will have to trigger the fiscal cliff before we can defuse it!

The financial markets will not like this kabuki dance. The stock market will plummet and stay down until a deal is done. But remember that we needed a stock market crash back in 2008 to get the "TARP" package finally passed after it had been rejected in the House of Representatives. It saved our banking system from imminent collapse.

Apparently, a sequel to this movie will be playing in time for us to see it this holiday season.

Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.

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