The United States Will Fall Off a Fiscal Cliff With No Safety Net In Place Unless the President and the Congress Amend Current Law.
This analysis is excerpted from the report “A Narrowly Divided Electorate Has Spoken: How Will The President And The Congress Respond,” issued by the law firm of Patton Boggs LLP. – ED
With President Barack Obama having been reelected and the Senate and the House having stayed in Democratic and Republican hands, respectively, attention now will turn to the lame duck session of Congress.
To put matters in perspective: Unless current law is amended, all of the Bush tax cuts will expire at the end of the year, as will various other temporary tax provisions (e.g., AMT relief for middle class Americans, extension of estate tax relief, and a variety of tax credits that are enjoyed by individuals, as well as the R&D tax credit and a host of other tax credits relied upon by the business community, some of which need to be extended retroactively to the beginning of 2012).
Congress and the Administration also must decide how to protect physicians serving Medicare patients from sustaining steep cuts in reimbursement rates and whether to extend enhanced unemployment insurance for the long-term unemployed. In addition, decisions need to be made whether to extend, replace, or allow to lapse the two percentage point payroll tax cut for all working Americans. Finally, $109 billion in across-the-board spending cuts (“sequestration”) mandated by the Budget Control Act of 2011 will begin to kick in on January 2.
Half of the automatic spending cuts will hit the Pentagon, while the other half will reduce spending by the rest of the government, with most agencies facing funding cuts of 8.2 percent. In popular parlance, the United States will fall off a fiscal cliff with potentially no safety net in place unless the President and Congress agree to amend current law.
Recognizing the dangers to the economy, the Administration reportedly is analyzing the extent to which it could use existing authority to buy additional time to reach an agreement with Congress early next year, such as by freezing the amount of money taken out of payroll checks by not updating tax withholding tables to reflect expiration of the Bush tax cuts on December 31.
The Administration also could seek to delay until later in the year automatic spending cuts that otherwise would begin on January 2. We do not expect the Administration to make its plans public any time soon, not least because identifying an escape hatch early could create the very outcome it hopes to avoid. And, in any event, it doesn’t have to come to this.
A great deal was accomplished in the lame duck session of 2010, in large part because Democrats and Republicans agreed to compromise. Both sides recognized that the economy needed a boost and that, by working together, they could resolve issues that until then had eluded resolution. In that environment, the President agreed to extend all the Bush tax cuts, as well as to extend other expiring or expired tax provisions, such as AMT relief. He also succeeded in pushing a major arms control treaty through the Senate. We expect a comparable effort this time as well, though the details on the tax policy side will likely be subject to intense negotiations, particularly on whether to limit extension of the Bush tax cuts to a particular income threshold.
To date, Congress has been unable and unwilling to agree to do anything, in part because of intransigence by both parties over whether to impose an income limit on an extension of the Bush tax cuts and in part because the “cost” of extending current law has been well beyond what Congress has been willing to “pay.”
As one example, a two-year extension of an AMT patch for middle-class families plus routine extension of expired and expiring tax provisions would cost $205 billion. In addition, delaying sequestration for an additional year would require $109 billion in new revenues or cuts to non-targeted programs (unless, of course, Congress punted by forcing nine years of cuts into eight, increasing the pain in future years).Over the last year, there has been bipartisan agreement that the fiscal cliff must be avoided and that a comprehensive overhaul of our tax code is necessary.
Nonetheless, the parties have fundamentally disagreed about how to approach these issues, with President Obama and Congressional Democrats arguing for significant tax increases as a means of deficit reduction, and Governor Romney and Congressional Republicans rejecting the idea that any direct tax increases are necessary, preferring that any new revenue come from assumed economic growth once tax reform is enacted.
The result has been a continued legislative stalemate, with a heavy dose of political posturing by both sides. But even close elections can be clarifying. A narrowly divided electorate now having spoken, we expect discussions to begin anew with some urgency in the lame duck session.
Given major philosophical differences on tax policy issues between the parties, it remains to be seen whether these discussions will lead to an agreement to avert the fiscal cliff while, at the same time, clearing the way for comprehensive tax reform. In our view, it is likely both will occur in the lame duck session (or shortly thereafter), beginning with agreement on a Bush tax cut extension coupled with a broad framework for a tax reform agreement, with the hard work of tax reform to span across 2013. Although there are a range of possible outcomes in the lame duck session and beyond, one thing is certain: in stark contrast to the last year, over the next few months we will finally see the parties undertake a serious discussion about tax policy.
In the lame duck session, for example, Congress might agree to legislation that would extend all (or most) expired and expiring tax breaks for six months to a year, tied to fundamental tax reform generating some agreed-upon amount in the hundreds of billions of dollars (or more) in overall deficit reduction over the next decade, with the threat of greater deficit reduction if the 113th Congress were to fail to act by then. Democrats will likely raise eliminating or modifying some tax measures, including those aimed at the oil and gas industry, to help offset the cost of forestalling the spending sequester or to make a “down payment” on future deficit reduction. Such an agreement also could mandate some further level of deficit reduction by seeking to compel the 113th Congress to reform entitlement programs such as Medicare and Medicaid next year.
Forcing hard decisions as a means of achieving deficit reduction of course is what the Budget Control Act of 2011 was supposed to accomplish by establishing the “Super Committee” and creating the threat of sequestration next year if Congress failed to agree to legislation reducing the deficit by at least $1.2 trillion over a decade. And it is precisely that failure that has the nation confronting the fiscal cliff. Many Senators and Representatives recognize the irony that the best way to prevent going over the fiscal cliff this year is to cut a deal that merely creates a bigger cliff that would arrive in another six or 12 months. But doing so would at least keep us at the precipice.