The front end of the financial deal now under negotiation in Washington is akin to the tip of the tax iceberg. It won’t appear threatening. But it’s what under the water that will really matter.
On the front end, the negotiators will likely craft a package of revenue increases carefully constructed to avoid the appearance of tax hikes. They will follow Mitt Romney’s lead in proposing a cap on deductions for upper-income people, but won’t agree to lower the rates as the Republican nominee had urged. The negotiators will seek all kinds of revenue “enhancements” by cutting industrial tax deductions, reducing tax subsidies to oil companies and the like. And they will probe deeply for revenues from the sale of federal lands and unused government-owned buildings.
But, on the back end, the deal will undoubtedly leave a “balloon” payment due — debt that will not be covered by the deal but which Congress will be forced to address at some future date. To deal with this additional piece of deficit reduction, Congress will enact the Democratic Party’s dream — a deal to raise taxes without making anyone vote for it.
Automatic taxation would be triggered by a failure to pass further deficit reductions or by backsliding on the spending cuts already enacted.
The spending cuts likely to ensue from the feel-good fiscal cliff deal will probably be in the non-defense discretionary party of the government spending pie chart. It is very unlikely that President Obama or the Democrats will agree to cuts in poverty-based entitlement programs like Medicaid, food stamps, subsidized housing and welfare. These programs will remain in tact, having almost doubled on Obama’s watch as president.
And here’s the rub: The increase in taxes and the failure to reach a comprehensive deal in the near term will probably cost the economy dearly in future growth. With unemployment up, expansion down and perhaps even a recession coming, these poverty-based entitlements will swell even further in their enrollments and benefits. As a result, the Congressional Budget Office will doubtless find that the deficit reductions measures of the short-term fiscal cliff deal have failed to reach their objectives. As a result, they will order more tax increases — and phony spending cuts — to make up for the shortfall.
Then Democrats will have what they wanted in the first place: few spending cuts — and those overridden by entitlement increases — and a lasting program of tax increases. And nobody will have had to vote for the tax hikes! They will simply take effect automatically under the terms of the fiscal cliff deal.
In fact, a long-term cycle of tax increases could ensue, slowing the economy and increasing entitlement spending followed by more tax increases to offset the falloff in revenues.
The key point about the fiscal cliff is not how we avert it, but that at its present incredible size, any path we choose will inflict massive economic harm, likely enough to tip us into recession. Tax increases, massive spending cuts, or merely adding more debt and printing more money will all lead to recession in whatever combination they are enacted.
The fault lies with Congress and the president for letting the fiscal balloon swell to these proportions. At this order of magnitude — four years of fiscal crises rolled into one by the annual postponement of a solution — the deficit is lethal no matter how it is paid off.
The only way out that would be somewhat painless was Romney’s solution of lowering tax rates as we cap deductions, a kind of revenue neutral tax cut. The cut in rates would offset the decrease in deductions and would stimulate the economy, growing our way out of the deficit just like we did in 1997.
But Obama’s victorious legions will insist on their revenge against the “rich” and will burden job creators with tax increases that will set in motion the vicious cycle we see on the horizon.