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Don't Rely on Lame Ducks

February 1, 2013 5 minute Read by David Malpass
A speedy resolution of the year-end fiscal crisis is unlikely. Nevertheless, the hope of a December deal on taxes has been appealing to financial markets eager for Washington to reduce the tax uncertainty. The October 2 edition of the New York Times ran a front-page story saying that there is bipartisan support for a three-step plan to avoid the fiscal cliff. The Washington Post ran about the same story on September 21 with the headline: “GOP retreat on taxes likely if Obama wins.” Both stories name only one Republican working in this direction — Senator Lamar Alexander of Tennessee. The thrust of both stories is that the budget and tax crisis may get resolved in a December lame-duck session of Congress, in part through a large bipartisan tax increase. That thinking understates the difficulty Washington faces in tackling the debt crisis. We expect a chaotic tax crisis in 2013 unless there’s a Republican sweep (and even in that scenario there would be a lot of headaches). The extreme tax uncertainty adds to the recession risk from QE3, Europe, and China. Taxes are one of the key variables in the economic outlook. Tax rates affect the after-tax return on investments, and tax complexity affects the cost of doing business. Current law is in flux because many tax rates are scheduled to go up at year-end. A few of these increases are the alternative minimum tax (AMT), the Medicare tax, the capital-gains tax, the estate tax, and the income-tax-rate reductions in President Bush’s 2003 tax act. The year-end “fiscal cliff” also includes automatic cuts in defense and Medicare spending, the scheduled reduction in Medicare payments to doctors, and the exhaustion of the debt ceiling. Even the best-case year-end fiscal scenarios will probably be bad for growth despite the media talk of a December lame-duck mega-deal. There may be some year-end damage control since both parties have a lot at stake — we call it “mutually assured destruction” due to rate hikes. For instance, both parties have something to lose from the combination of the heavy AMT tax increase (which is aimed at blue states), the doc fix, expiring tax credits, and the sequester hitting both defense and non-defense spending. However, a near-term comprehensive fix is unlikely (see “Difficult Tax Scenarios Add To Recession Risk,” from September 13). The New York Times story says “Lawmakers would vote on expedited instructions to relevant Congressional committees to draft the details over six months to a year.” This is probably a reference to the reconciliation process, but it requires active House participation, which is unlikely unless the Republicans sweep. The NYT article quotes Senate Majority Leader Harry Reid saying President Obama won’t sign a bill that extends tax cuts for the rich and House Speaker John Boehner saying he will not accept any bill that decouples the Bush rate cuts. The Washington Post article asserts that Republicans will approve big tax increases in order to stop defense cuts. The game in Washington is to keep talk of a mega-deal going into December, but there’s very little common ground for a deal. The December 2010 deal consisted of both parties and the President getting their preferred tax cuts and extenders, without much spending offset. That deal would be harder to close in 2012, for several reasons. First, President Obama and the Republicans have been more specific on their differences (for example, on the top marginal rate in the quotes above, and also on the Obamacare tax increases and other areas). Second, the national debt is much bigger now than it was in 2010 (see the chart below), making it harder to vote for a lame-duck tax cut. Third, the deficit impact of extending the current rates is higher than in 2010 because of Congress’s odd scoring system; just the President’s desired tax cuts would be immensely costly. Finally, the House and Senate became more conservative due to the 2010 election and the 2012 campaign (e.g., Richard Lugar will be gone, Orrin Hatch had a Tea Party primary, etc.), making compromise with President Obama less likely. In sum, the deal being touted in the New York Times and Washington Post is more tax-and-spend oriented than the 2010 deal, yet Congressional membership is more fiscally conservative than in the December 2010 lame-duck session. There may be some damage control in December, but we expect tax chaos extending into 2013 plus battles over spending and debt that will become as tense and frustrating as those in 2011.

Author

David Malpass

2012 Economic Growth Fellow

David Malpass is president of Encima Global, and chairman of GrowPac. He writes a regular Current Events column in Forbes magazine, and his opinion pieces appear regularly in the Wall Street Journal. He sits on the boards of the Economic Club of New York and the National Committee on U.S.-China Relations. Formerly, Mr. Malpass was chief economist of Bear Stearns. Between February 1984 and January 1993, he held economic appointments during the Reagan and Bush Administrations. He was Deputy Assistant Treasury Secretary for Developing Nations, a Deputy Assistant Secretary of State, Republican Staff Director of Congress’s Joint Economic Committee, and Senior Analyst for Taxes and Trade at the Senate Budget Committee.

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