Weekly Standard Online
November 10, 2012
by Irwin Stelzer
The robocalls have stopped. Television ads have gone from attacks on candidates to the usual pitches for medications and exercises that will enable you to live forever. Political post-mortems are under way. And the 2016 wannabees are lining up financing and staffs for their runs at the Democratic and Republican nominations. This will be a relatively easy task for the Clintons should Hillary decide to make a run, but might be more difficult for New Jersey governor Chris Christie, whose embrace of the president during their televised tour of the damage from Sandy helped Obama to dispel the notion that he couldn't work across party lines. They say that revenge is best eaten cold, and Republican primary voters just might serve up that dish three or four years from now.
The Obamas don't have to move back to Chicago, the Democrats still control the Senate, the Republicans still control the House of Representatives, and two fiscal "events" still loom. Before year-end America will hit the debt ceiling, which prevents it from borrowing money to meet its obligations-the ugly word for that is default. Then, as we ring out the old and ring in the new, we fall over "the fiscal cliff."
Avoiding both events will require compromises, not politicians' long suit. Don't be fooled by President Obama's victory speech, calling for a bipartisan coming together. It is almost verbatim the speech he made after his victory in 2008, before passing Obamacare without a single Republican vote and pushing through a stimulus package on almost the same partisan basis. So the country finds itself with a presidential believer in big government confronting an opposition that just as passionately believes in reducing the role of government in the lives of most Americans.
You will recall that the last battle over the debt ceiling resulted in the loss of our AAA bond rating. Because that downgrading had little or no effect on the interest rate paid by the Treasury on its bonds, both parties are emboldened to dig in their heels even at the risk of another downgrading. The Republicans say they will agree to raise the ceiling only if the Democrats agree to equal cuts in spending. My guess is that this will be solved by accounting fudges of the sort that would result in long prison sentences if indulged in by private sector businesses and their auditors.
The fiscal cliff poses a less easily solved problem. Unless some compromise is reached, tax increases and spending cuts will combine to slice 4.3 percent out of GDP-a cut of Grecian magnitude-just when most Americans are singing Auld Lang Syne. The Congressional Budget Office reckons that will cause the economy to shrink by 1.3 percent in the first half of 2013, before recovering sufficiently in the second half to produce full-year growth of 0.5 percent. The most reliable Washington sources (I am not unaware that "reliable" and "Washington sources" might be an oxymoron) tell me that there will be a deal to avoid a plunge over the cliff: Republicans will give in to a few Democratic demands to raise taxes, perhaps on those earning more than $1 million per year, and then both parties will "kick the can down the road," giving them time to agree to some "grand bargain" to reduce the deficit.
Speaker Boehner has announced that he would agree to "revenue enhancements" if Democrats agree to spending cuts, especially on entitlement programs that, left in their present form, would bankrupt Medicare. "Revenue enhancements" differ importantly from increases in marginal tax rates, since the new revenues result from ending various tax breaks, such as lower tax rates on dividends and capital gains, and the deduction of interest payments on mortgages. This broadening of the tax base, which would hit mostly high earners, supposedly has bipartisan support, although the president continues to believe that "fairness" dictates levying higher marginal rates on everyone earning more than $200,000 ($250,000 for families). If he doesn't get his way he very well might let the Bush cuts expire, and then introduce a bill to lower rates on all save the higher earners-and dare Republicans to vote against those tax cuts.
When all is said and done, any compromise will almost certainly raise effective income tax rates on higher earners, either from an increase in marginal rates, or a curtailment of deductions. Whatever else happens, the Obamacare tax of 3.8 percent on investment income will add a bit more gloom to high earners as they contemplate their prospects for the next four years, and decide just how much they want to invest in small businesses and in extra effort. Whether tax reform that eliminates special treatment of the income from dividends, capital gains and hedge fund operations can be negotiated is difficult to predict, since the parties that would be affected have already lined up lobbying teams to protect their benefits, and congressmen are already scrounging for campaign funds for their 2014 election campaigns.
The battle between Democrats and Republicans over how to cut the deficit, and at what pace-with some opposed to any cuts just yet-is not the only one that has been joined. There are other battles, these the president is almost certain to win. Having "transformed" the health care sector, the descriptive Obama prefers to "reformed" when he lays hands on some sector the American economy, the president is aiming to complete his transformation of the energy sector as part of his promise to turn his attention in this final term to the perceived problem of global warming. Permits to drill for oil and gas on federal lands will be harder to come by; subsidies for wind and solar will be easier to get, despite the record of bankruptcies of firms that have benefitted from the infusion of taxpayer funds; the Yucca Mountain nuclear waste disposal site will remain closed, adding to the difficulty of building new nukes; taxes on oil companies will go up; approval of the Keystone Pipeline to bring crude oil down from Canada, although still possible, is less likely; and new regulations to slow the pace of development of shale gas and oil are likely.
Also, the election of consumer advocate Elizabeth Warren to represent Massachusetts in the senate will help Obama to force a quickening of the pace at which regulations to implement the Dodd-Frank banking reform law will be churned out. We might see sooner rather than later just how the Volcker rule, separating investment banking and risky trading from plain vanilla consumer lending, will be implemented.
Finally, having sorted out fiscal policy, and put in place a regulatory regime, the president will have to begin considering two important appointments, in addition to finding a new director of the CIA. With four Supreme Court justices well into their 70s, and one of them crowding 80, Obama will have at least one and possibly two vacancies to fill. Although such appointees do not always vote as the president who appointed them had hoped, Obama's picks are more rather than less likely to tip the court in a liberal direction, supporting the constitutionality of government actions that a more conservative court might find transgresses constitutional limitations.
Then there is the Federal Reserve Board. Ben Bernanke, appointed by George W. Bush and reappointed by Obama, has let it be known that he will not seek reappointment when his term as chairman expires at the end of January 2014. If he sticks to his plan to return to Princeton, Obama will want to replace him with someone at least as inclined as Bernanke has been to print money in order to shore up the economy so that if fiscal policy is tightening in order to cut the deficit, monetary policy will remain loose. After all, Obama would like to leave office with unemployment lower than it was when he was sworn in in 2009.
The leading candidate is economist Janet Yellen, currently vice chair of the Fed board, and formerly president of the San Francisco Fed and chair of Clinton's Council of Economic Advisers. Yellen favors an even more aggressive monetary policy than Bernanke, risking higher inflation if that is what is necessary to bring down unemployment. Also in the running is Roger Ferguson, Jr., Fed vice chairman from 1999 to 2006, and now CEO of the massive teachers' retirement fund. Ferguson is a well-regarded economist who, if appointed, would be the first black Fed chairman. Larry Summers has been mentioned as a possibility, but the high IQ that qualifies him for the job must be balanced against the fact that he is not famous as a consensus builder.
President-elect Obama surely has a full in-tray. But given the alternative, he is not complaining.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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