Finance

The first battle in a much larger war

Beyond the fiscal cliff there are mighty confrontations on the horizon, explains Allianz of America government policy expert Peter Lefkin.
A protestor holds a picture of former U.S. President George Washington crying as several groups .../ Credits: Reuters
Allianz knowledge on demography: Peter Lefkin, Senior Vice President, Government and External Affairs, Allianz of America Corp. Peter Lefkin, Senior Vice President, Government and External Affairs, Allianz of America Corp: "The broader public will also be asked to look in the mirror as they have generally welcomed the expansion of governmental benefits, as long as they did not have to pay for it." Better late than never. The new fiscal-cliff legislation was drafted and signed by the president on January 2, just hours before Congress convened for the first time in 2013. But lawmakers were far from thrilled with the outcome. While the law addressed some of the hot-button tax issues and near term spending concerns, it failed to establish a viable plan to address the nation’s long-term fiscal problems.

Republicans had hoped that their willingness to accept $800 billion in tax increases through limited tax deductions and preferences for upper-income individuals would be met with even larger cuts in federal spending. The most notable haircut would have included Social Security, Medicare and Medicaid.

These entitlement programs have doubled as a percentage federal spending and their fiscal trajectory is unsustainable. Nearly four million baby boomers are retiring each year, transitioning from net payers of federal benefits to net receivers.

Specifically, two issues that frustrate Republicans are the alternative minimum tax (AMT), which has long ignored the ill effects of inflation and the doc fix, which reimburses doctors who treat Medicare patients.

Senate Minority Leader Mitch McConnell and House Speaker John Boehner tried to preserve as much as they could while softening the blow of tax increases to the top 2% of taxpayers. But they took some solace in the fact that the tax increases for capital gains, dividends and estate and gift taxes were not as much as the President had demanded.

With those tax rates being made permanent, it will be much harder to increase them in the future. Similarly, a 39.6% tax rate kicks in for married couples earning $450,000 and individuals earning $400,000, well above the $250,000 and $200,000 originally demanded by the president.

The net impact is about $600 billion of new revenues over the next ten years, which is far less than the comprehensive $4 trillion in savings that both sides had hoped for originally in a broader comprehensive agreement. In the end some 85 percent of the Bush tax cuts have been preserved.
The first major action of the new Congress will be to increase the debt ceiling before March. The United States hit the limit on December 31, 2012, but it will not technically default for a few more months. Immediately following the fiscal-cliff deal, Republicans announced they would not raise the debt ceiling without significant cuts to federal spending. They have argued that the nation cannot continue to run $1 trillion annual deficits, and that they will not support any increase to the debt ceiling unless it comes with a serious commitment to reduce spending.

In the days after the fiscal-cliff legislation was enacted, Congressional Republicans have been arguing that the receipt of $600 billion in additional tax revenue, while meaningful to the taxpayers, is largely insignificant in the context of the larger annual budget deficits and national debt.

They will be demanding comprehensive changes to entitlement spending, and with the whiff of the fiscal cliff over, their political hand will be strengthened. Middleclass taxpayers have been mostly spared any tax increases, and with upper-income individuals having already paid a little more, the president will be restricted to a limit on what he could demand.

Expect a replay of the hardball politics on not only the debt-ceiling legislation, but also the budget battles that were simply avoided in the fiscal cliff deal—scheduled automatic spending cuts and legislation avoiding a federal government shutdown.

Another point of contention in the debate over the debt ceiling is the need for budget plan. Republicans argue that the nation demands a framework that will guide future expenditures, particularly when enormous deficits show little signs of subsiding.

Cynics argue that while this idea may have some merit, current law already compels action. So far, it has been ignored by the Senate’s Democratic leadership. In these debates the Democrats will be hoping that the memories of the 1995 government shutdown under former Speaker Newt Gingrich (R-Ga.) would cause the Republicans to back off, just as they did on the recent fiscal cliff and the debt-ceiling debate in August 2011.
Many political observers still remember the public anger aimed at the Republicans for the government shutdown in 1995, which forced the White House, to rely on interns, including Monica Lewinsky. Yet, Republicans have less incentive to compromise now than they have in the past.

Having just raised taxes on the wealthy, it will be easier for them to push back against efforts to raise them again, particularly when the amount of revenues that are being demanded by Democrats would still leave the nation with substantial annual deficits.

Feeling that unlike the fiscal-cliff debate, where the public was mostly against them, they can be expected to take a harder position on the debt ceiling and related budget battles, Unless significant action is taken fairly soon, the nation will be not be able to fulfil its promises made to baby boomers, and will be imposing a huge financial burden on future generations.

I expect some variation of a broader agreement to develop. However, making it different than the Fiscal Cliff will require some fundamental changes to entitlement spending, which will create heartache for a large number of Congressional Democrats and their constituents.

The broader issue continues to be the fact that since about 1960 the nation has been borrowing consistently to pay for current consumption. And with the public debt now about 75% of GDP and 100% if it includes Treasury Department intra-government debt to Social Security, this is unsustainable.

Politicians are to blame, of course, but the broader public will also be asked to look in the mirror as they have generally welcomed the expansion of governmental benefits, as long as they did not have to pay for it.

In the one instance when they were forced to pay the bill - a Medicare Catastrophic Coverage bill enacted in July 1989 -senior citizens who received the benefits went into open rebellion, causing Congress to repeal the law just about six months later.

For this and probably few more reasons, President George W. Bush’s Medicare Drug Benefit bill of 2003, which costs about $60 billion annually and which has remained popular, is 75% paid for by government borrowing. The rest is subsidized by the recipients themselves.

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