Investors had not even begun celebrating the Congressional agreement to forestall the “fiscal cliff” plunge when Washington watchers and Wall Street wags alike began warning against cheering too long or loudly. The deal to allow tax rates to rise on high earners represents a fragile and flawed partisan peace, they pointed out – one that will quickly give way to a grim, three-stage budget fight in the coming months.
As the Dow industrials surged 300 points on the first trading day of 2013, amid relief that a threatened half-trillion dollars worth of tax hikes and automatic government-spending cuts wouldn’t kick in right away, the rally was shadowed by the need for Congress to agree on vexing long-term spending measures before spring. A two-month delay in the automatic 10% cuts to many government agency budgets will expire in early March, just as the nation’s borrowing limit will need to be raised and an annual measure funding the government must be passed.
The Debt-Ceiling Battle
The rapidly coalescing conventional wisdom is that Republicans, who split their vote on the tax deal, will have all the leverage in the coming debt ceiling debate, under which Congress must raise the borrowing limit or risk the U.S. government’s defaulting on its debt.
Republicans, of course, held the debt ceiling hostage in the summer of 2011 to the point of triggering a credit-rating downgrade of the U.S. Treasury, so why wouldn’t they demand deep long-term cuts to Medicare and Social Security in order to support another debt-limit deal? President Obama, for his part, has said repeatedly that he will not partake in negotiations over the debt-limit increase, which he has cast as simply a necessary fulfillment of Congress's obligation to pay bills it has already racked up.
So one party is intent on shrinking budget deficits substantially before raising the country’s credit limit, and faces a president who claims he won’t even enter negotiations on these terms. This certainly carries the powerful threat of more bad-faith posturing, brinksmanship and unsatisfying outcomes that commentators have been quick to point out. Some are even suggesting that Congress is on a treadmill of institutionalized budget-deadline roulette and that years of bitter warfare over entitlements, deficits and taxes await.
The compound threat of a lit fuse on $100 billion in automatic spending cuts set to burn down right before another debt-limit standoff starts could well upend investor and consumer confidence the way it did in 2011, when the Dow fell nearly 20% in a matter of weeks and fears of a relapse into recession flared. Even if a lasting budget arrangement is arrived at in the end, the process will almost certainly be messy, with plenty of opportunity for public disgust with the system to reach new heights.
A Low-Drama Outcome?
Yet what if the chances for a low-drama outcome are higher than commonly believed, just as we’ve all become resigned to a new apparent reality of maximum Washington budget dysfunction?
This notion begins with the fact that President Obama achieved his one explicit, hard-line campaign promise by taking back the Bush tax cuts from upper-income taxpayers. The stakes that remain are certainly huge – long-term entitlement obligations, historically high defense spending, the president’s stated desire to set aside funds for infrastructure rebuilding. But they are less immediate, specific or politically toxic, and involve fewer “nonstarter” policy positions at the outset. The long-term nature of a possible “grand bargain” on entitlement and tax reform means the argument can occur mostly in the imaginary legislative universe of 10-year budget projections and accounting maneuvers.
It is at least conceivable that the president, having seen House Speaker John Boehner and the Senate GOP edge toward some middle ground, will use his inaugural speech and/or State of the Union address to strike a statesmanlike, post-partisan, legacy-etching posture. He has already reportedly entertained such ideas as raising the eligibility age for Medicare and altering the inflation calculation for Social Security that would make benefits less generous – once anathema to Democrats.
From the Republican perspective, there is no doubt that the deficit-slashing rhetoric and promises will be loudly asserted, right up to the point of any agreement. With tax rates set permanently, though, the entire conversation will now occur between two sides who both say they are determined to deal with “structural” deficits over the extended horizon. That means the debate will be over how much and by what means spending trajectories are altered – not whether they ought to be.
Perhaps this is wishful thinking on a day when all the alarmist headlines and panicky market action about the hazards of the Dec. 31 fiscal-cliff deadline in recent months seem suddenly to have been misplaced. But when expectations for compromise are at such depressed levels, they are that much easier to exceed under the right circumstances.