Here are a few points on the sequester I haven’t seen elsewhere or I think deserve special emphasis.

Sequester replacement was mostly for show

As best I can tell there were no negotiations across the partisan aisle on how to replace the sequester. The President did some campaigning outside of Washington. Even if he had expected Congressional Republicans to fold to this pressure, his team was not doing the staff-level work needed to actually make legislation happen. And while leaders of both parties claim to hate the sequester, neither side hated it enough to be willing to even begin negotiations over how to pay for its replacement. The competing sequester replacement plans and the rhetoric on both sides look like they were mostly for public positioning and Member management within the Congressional caucuses rather than serious attempts to change the law.

Why the sequester will hold

There are two distinct legislative coalitions that in theory could unwind the sequester. In both hypothetical coalitions cuts in both defense and non-defense discretionary spending would be unwound.

One would be a center-left alliance formed by pro-defense spending Republicans agreeing to raise taxes and cut farm subsidies. These Republicans would be deciding that avoiding defense spending cuts is more important than preventing additional tax increases.

The other would be a center-right alliance formed by Democratic appropriators agreeing to drop their party’s tax increase demands and pay for higher discretionary spending offset entirely by entitlement spending cuts. These Democrats would be deciding that they care more about spending money than about extracting more from the rich.

These coalitions will never form as long as the sequester issue is being controlled by the President and the four Congressional leaders. Each of these five is working principally to hold his or her party intact, and each has so far succeeded. A coalition to replace the sequester would have a chance only if the issue were being handled below the leadership level, most likely in the House and Senate Appropriations Committees. In these committees everyone’s priority is to increase discretionary spending and both sides would be more likely to show flexibility on offsets. Since the issue remains squarely in the hands of the President and the party leaders I expect the sequester will hold indefinitely.

In addition, the optical damage of the cuts affects only the next seven months. If the continuing resolution extends post-sequester spending levels, then the implementation of next year’s sequester won’t show up as a “spending cut,” but instead as a slight increase (say, +2% for inflation) from this year’s spending levels. To the extent the political and press blowback from cutting spending arises from the optics of a decline in spending, that decline takes effect only this year. After that it’s built into the baseline, at least in a political sense.

Watch the CR for spending flexibility and maybe a little money

I instead expect the appropriators to instead pursue more modest versions of the same goals through quietly shaping the upcoming Continuing Resolution. The appropriators appear poised to give targeted flexibility to the Administration in a few limited areas where they agree that the sequester will impose too much pain, and they might even try to shift a few billion dollars around here and there. The Administration claims they are still opposed to funding flexibility. I think they’re irrelevant on this point and the Appropriators will now quietly exert process and legislative language control to minimize the policy harm from the sequester. And the more flexibility the appropriators provide, and the more they shift funds (within what I hope is a fixed post-sequester topline) to address sequester-driven policy harm, the more likely the sequester will be sustained over time.

The White House’s management challenge

While Team Obama now says the sky will now drop gradually rather than fall suddenly, they are sticking to their line that the pain from these spending cuts will be intolerable and will/should force Congress to increase taxes and discretionary spending.

With this argument they create a management challenge for themselves. They need the harm from these cuts to be severe and visible. The more harm is done and felt, the more likely that Republicans will relent to the president’s position (or so goes this logic). More policy harm creates more legislative pressure.

But the TSA manager at O’Hare or Logan or LaGuardia wants to minimize policy harm in his area, not maximize it. Sure he’d like more funding, but from his perspective there’s little he can do to influence Congress on something as big as the sequester. And since he will personally take the public heat for long security lines in his airport, his goal is to make do as best he can and minimize the harm done by the cuts.

The same is true for every program manager throughout the government. Each is judged on how well her program meets its goals given the funding available. If we simply assume that these managers will try to do their jobs as effectively as possible, both for noble policy reasons and for personal reputational reasons, then they will be working at odds with the President’s strategic goal of maximizing visible harm to undo the sequester. They will be trying to minimize the damage done while the President wants the opposite.

Playing a longer game?

It is possible the President’s primary goal is not to replace the sequester with offsets that he prefers. Sure he’d prefer that policy outcome, but it’s hard to believe that he and his team were so clueless that they actually thought his recent barnstorming would cause Republicans to fold and agree to raise taxes. Again.

Charles Krauthammer has suggested the President is instead playing a longer game, that his strategic goal is instead to win Democratic majorities in 2014 rather than to win a tactical victory by extracting a few tens of billions of dollars now from the House Republican majority. If Mr. Krauthammer is right, then the goal of barnstorming is to further damage the Republican brand rather than to enact legislation in the short run.

The other obvious benefit to the barnstorming is that without a deal to replace the sequester, the President now has a new target for blame-shifting in his macroeconomic message.

  • Old message: All economic bad news is George W. Bush’s fault, all good news is because my policies are working.
  • New message: All economic bad news is Congressional Republicans’ fault, while all good news is because my policies are working.

Both these “long game” explanations are dispiriting. That doesn’t mean they’re wrong.

The deficit does not measure the size of government

The deficit does not measure the size of government

In his State of the Union Address President Obama said:

Let me repeat – nothing I’m proposing tonight should increase our deficit by a single dime. It is not a bigger government we need, but a smarter government that sets priorities and invests in broad-based growth.

Let’s set aside for the moment the question that others have raised, the credibility of his claim that his proposals will not increase the deficit. Even if the President’s new proposals don’t increase the deficit they will still make government bigger because they increase government spending.

The deficit does not measure the size of government. It instead measures how economic resources are allocated over time to finance government spending. When we increase the deficit we reallocate some future income to today for government to spend. When we reduce the deficit we are taking less future income to pay for today’s government spending.

When the President says he won’t increase the deficit, he is saying he will not increase the amount of future income taken to pay for increased government spending today. In effect he is promising not to create an additional burden to raise future taxes beyond what’s in current law. He is not saying he won’t increase government spending today and raise current taxes by an equal amount, which is what we mean by government getting bigger.

As a fiscal matter we should measure the size of government by the amount government spends, not by the difference between what it collects and what it spends (the deficit). Suppose in our $16 trillion economy you were to increase government spending by $320 billion per year and increase taxes by the same amount. The deficit would be unchanged but government would be $320 billion per year bigger.

For the 50 year period before the 2008 financial crisis total federal government spending averaged 20.1% of GDP. CBO tells us it’s 22.2% this year and projects that under current law it will average 22.1% over the next decade. That means the federal government is and will continue be 10% bigger than it his has historically been, relative to the economy. If we were to use real dollars rather than percent of GDP we’d measure an even bigger increase. As a fiscal matter the federal government is and will be significantly bigger than it has historically been.

If you increase government spending you make government bigger, even if you pay for that spending with higher taxes. To make government smaller, cut government spending.

In addition to fiscal expansion the federal government has also massively increased its regulatory scope in the past four years, especially in health care and financial services. The President proposes that in the next four years he’ll do the same to the energy sector.

President Obama is correct that we don’t need a bigger government. Unfortunately, that is what has resulted from his first term and what he proposes for his second.


The President’s sequester remarks, annotated

The President’s sequester remarks, annotated

My annotations follow each portion of the President’s remarks on the sequester today.

THE PRESIDENT:  Good afternoon, everybody.

I wanted to say a few words about the looming deadlines and decisions that we face on our budget and on our deficit — and these are decisions that will have real and lasting impacts on the strength and pace of our recovery.

Yesterday was the legal deadline for the President to submit his budget to Congress. Not only did he miss the deadline again this year, but his team has given no indication of when they will meet this legal requirement.

In these remarks the President proposes to delay immediate spending cuts and substitute a combination of (future, I think) spending cuts and tax increases. Even if you believe this will have a “real” effect on our recovery, it won’t have a “lasting impact” on it. A temporary loosening of fiscal policy would, at most, temporarily goose economic growth. That’s not “lasting.”

THE PRESIDENT: Economists and business leaders from across the spectrum have said that our economy is poised for progress in 2013.  And we’ve seen signs of this progress over the last several weeks. Home prices continue to climb.  Car sales are at a five-year high.  Manufacturing has been strong.  And we’ve created more than six million jobs in the last 35 months.

And GDP was flat last quarter … and the unemployment rate ticked up last month. 6M / 35 = +171K jobs/month, which when unemployment is high is nothing to brag about. “Our economy is poised for progress” is what you say when you can’t say “our economy is growing now.”

THE PRESIDENT: But we’ve also seen the effects that political dysfunction can have on our economic progress.  The drawn-out process for resolving the fiscal cliff hurt consumer confidence.  The threat of massive automatic cuts have already started to affect business decisions.  So we’ve been reminded that while it’s critical for us to cut wasteful spending, we can’t just cut our way to prosperity.  Deep, indiscriminate cuts to things like education and training, energy and national security will cost us jobs, and it will slow down our recovery.  It’s not the right thing to do for the economy; it’s not the right thing for folks who are out there still looking for work.

He argues that the past drawn-out process caused uncertainty which hurt consumer confidence. He recently made a similar argument against a short-term debt limit extension. But eight paragraphs from now he proposes to delay the sequester, further “drawing out” that process, to allow time to substitute different spending cuts and tax increases for the sequester. By his own logic, his proposal should further hurt consumer confidence.

I’m not sure how to respond to his point that immediate government spending cuts cause economic harm, because he has no proposal to tell us what he wants instead. If he proposes to change the mix of deficit reduction (more tax increases and defense spending cuts, fewer nondefense spending cuts) but not the timing, then all he’s doing is shifting resources from the private to the public sector, and from one part of government to another. That’s going to have no short-term growth effect and will hurt long-term growth because the private sector is smaller.

If instead he wants to substitute future deficit reduction for that which is about to begin March 1, then he is, in effect, arguing that given a weak economy, our budget deficit this year ($845 B or 5.3% of GDP) isn’t big enough. This is a traditional Keynesian fiscal stimulus argument. But his problem is that the numbers are too small: the sequester will cut spending this calendar year by about $65 B. Even if you push all that deficit effect into future years, you’re not going to move the needle much on a $16 T economy.

The deep indiscriminate cuts to which he refers are the result of the sequester that his advisors proposed to Congress in July of 2011 and which he signed into law that August.

And he argues that cutting government spending now would harm the economy and “folks who are out there still looking for work,” but his solution means that government employees would be protected from job loss while those previously employed in the private sector had to suffer the pain of a weak labor market. That doesn’t seem fair.

THE PRESIDENT: And the good news is this doesn’t have to happen.  For all the drama and disagreements that we’ve had over the past few years, Democrats and Republicans have still been able to come together and cut the deficit by more than $2.5 trillion through a mix of spending cuts and higher rates on taxes for the wealthy.  A balanced approach has achieved more than $2.5 trillion in deficit reduction.  That’s more than halfway towards the $4 trillion in deficit reduction that economists and elected officials from both parties believe is required to stabilize our debt.  So we’ve made progress.  And I still believe that we can finish the job with a balanced mix of spending cuts and more tax reform.

He’s got a small verb tense problem and a large logic problem here. Policymakers have cut the deficit by less than $100 billion so far, and they have enacted policies which, if not unraveled by future laws, would result in another $2.4ish trillion in deficit reduction over the next nine years. But all these future savings are from cutting discretionary spending, which is what the President is (ambiguously) proposing to undo here. It seems a bit hypocritical to simultaneously claim credit for enacted future cuts in discretionary spending at the same time you propose to undo them. The President would have more credibility here if he were proposing specific spending cuts and tax increases to substitute for the spending cuts he wants to undo. But the only thing he is specific about is that he wants to undo or delay the impending spending cuts.

THE PRESIDENT: The proposals that I put forward during the fiscal cliff negotiations in discussions with Speaker Boehner and others are still very much on the table.  I just want to repeat:  The deals that I put forward, the balanced approach of spending cuts and entitlement reform and tax reform that I put forward are still on the table.

But what exactly are those proposals, and will the President propose them in his budget? If he is willing to use a chain-weighted CPI for COLAs and tax bracket indexation, will he propose it? If he is willing to raise the eligibility age for Medicare, will he propose it? If not, how do we know what he is actually proposing? By reading Bob Woodward’s book and background quotes from unnamed senior advisors in POLITICO? He has never told us what this deal is that he put forward, nor has he proposed it to anyone other than Speaker Boehner. If you think it’s good policy, Mr. President, then put it in your budget.

Also, the deal in December has to be modified, right, since a new law enacted $600+ B of current and future tax increases? So technically the deal the President put forward then at a minimum has to be updated to reflect the new law, right?

THE PRESIDENT: I’ve offered sensible reforms to Medicare and other entitlements, and my health care proposals achieve the same amount of savings by the beginning of the next decade as the reforms that have been proposed by the bipartisan Bowles-Simpson fiscal commission.  These reforms would reduce our government’s bill — (laughter.)  What’s up, cameraman?  (Laughter.)  Come on, guys.  (Laughter.)  They’re breaking my flow all the time.  (Laughter.)

He mentions only one of the Big 4 entitlements. He and his party slowed Medicare spending growth in 2010, but then they turned around and spent those savings on a new health entitlement. Now he proposes again slowing Medicare spending growth, but ignores the other three sources of medium-term spending growth: Social Security, Medicaid, and the new health subsidies from the Affordable Care Act.

THE PRESIDENT: These reforms would reduce our government’s bills by reducing the cost of health care, not shifting all those costs on to middle-class seniors, or the working poor, or children with disabilities, but nevertheless, achieving the kinds of savings that we’re looking for.

Translation: He’ll cut medical provider payments rather than raise copayments, deductibles, or premiums.

THE PRESIDENT: But in order to achieve the full $4 trillion in deficit reductions that is the stated goal of economists and our elected leaders, these modest reforms in our social insurance programs have to go hand-in-hand with a process of tax reform, so that the wealthiest individuals and corporations can’t take advantage of loopholes and deductions that aren’t available to most Americans.

Translation: I’m not touching the big entitlements unless Republicans raise taxes (again, more) at the same time.

I disagree that his proposals “achieve the kinds of savings we’re looking for,” and that “the full $4 trillion in deficit reduction” is the right target, given that his stated goal is only to get the deficit down to 3% of GDP for the next decade. We need more savings now to start reducing debt/GDP, and we need long-term spending cuts for when entitlement spending growth is otherwise projected to explode. We need much more than $4 trillion of deficit reduction over the next decade, and it’s incorrect to suggest that there is a consensus among elected leaders on that point.

The “loopholes and deductions that aren’t available to most Americans” language is new to me. I wonder what he means? Tax deductions have greater dollar value to a high-income taxpayer than to “most Americans,” but both taxpayers have these preferences “available to them.”

THE PRESIDENT: Leaders in both parties have already identified the need to get rid of these loopholes and deductions. There’s no reason why we should keep them at a time when we’re trying to cut down on our deficit.  And if we are going to close these loopholes, then there’s no reason we should use the savings that we obtain and turn around and spend that on new tax breaks for the wealthiest or for corporations.  If we’re serious about paying down the deficit, the savings we achieve from tax reform should be used to pay down the deficit, and potentially to make our businesses more competitive.

Here’s the President’s position, as best I can infer:

  1. Raising taxes to offset tax cuts: Bad;
  2. Raising taxes to reduce the deficit: Good but he’s not proposing it;
  3. Raising taxes to increase spending: He’s proposing it while pretending he’s doing #2.

He argues that raising taxes to reduce future deficits is a good thing, but as I understand it he wants to raise taxes to pay for more government spending (by undoing the spending sequester). That’s quite different.

THE PRESIDENT: Now, I think this balanced mix of spending cuts and tax reform is the best way to finish the job of deficit reduction.  The overwhelming majority of the American people — Democrats and Republicans, as well as independents — have the same view.  And both the House and the Senate are working towards budget proposals that I hope reflect this balanced approach.  Having said that, I know that a full budget may not be finished before March 1st, and, unfortunately, that’s the date when a series of harmful automatic cuts to job-creating investments and defense spending — also known as the sequester — are scheduled to take effect.

I don’t blame the American people for agreeing with the President; he is personally popular and it is impossible for them to understand what he is proposing. He has never publicly described or proposed the deals he privately offered to Speaker Boehner. He hasn’t proposed a budget this year and doesn’t appear likely to do so soon. He calls government spending “investment,” tax increases “tax reforms,” and welfare payments “tax cuts.” He keeps shifting baselines against which he measures “balance” and he repeatedly conflates taxes and spending. I have been studying and working on fiscal policy for more than 15 years and I can barely understand what he’s saying. No wonder the American people are confused and frustrated.

He says, “I know that a full budget may not be finished before March 1st”:

  • He missed the statutory deadline for proposing a budget and is creating further delays and uncertainty by not even announcing when he will propose a budget, complicating the jobs of both the House and Senate budget chairmen.
  • The (often missed) deadline for a budget resolution conference report is April 15th.
  • So it’s unfair to suggest that Congress is somehow failing by not finishing a full budget by the March 1 sequester deadline.

THE PRESIDENT: So if Congress can’t act immediately on a bigger package, if they can’t get a bigger package done by the time the sequester is scheduled to go into effect, then I believe that they should at least pass a smaller package of spending cuts and tax reforms that would delay the economically damaging effects of the sequester for a few more months until Congress finds a way to replace these cuts with a smarter solution.

Who in Congress is seriously discussing now “acting immediately on a bigger package?” Anyone? The Grand Bargain died on New Year’s Day with the enactment of a $600+ B tax increase. This is another straw man so that the President can repeatedly say “I’m for a big deal” while making no new concessions to get one done nor taking any steps to create an environment in which such a deal might happen. The “if” clause above is therefore trivially true. The President is saying Congress should replace or delay the sequester for a  few months but he offers no specific proposal to do so.

THE PRESIDENT: There is no reason that the jobs of thousands of Americans who work in national security or education or clean energy, not to mention the growth of the entire economy should be put in jeopardy just because folks in Washington couldn’t come together to eliminate a few special interest tax loopholes or government programs that we agree need some reform.

Yes, there is:  Because if you enact a law now that raises taxes now and promises to cut future spending, what is to say that those future spending cuts won’t again be delayed, just as the President is proposing to do now? Also, shifting resources from the private sector to the public sector (aka “tax-and-spend”) doesn’t increase economic growth, it stifles it.

And he’s exaggerates when he suggests that “the growth of the entire economy” is contingent on whether government spending is cut by four-tenths of a percent of GDP this year.

THE PRESIDENT: Congress is already working towards a budget that would permanently replace the sequester.  At the very least, we should give them the chance to come up with this budget instead of making indiscriminate cuts now that will cost us jobs and significantly slow down our recovery.

Are they? Maybe the Senate is. I’m not sure the House is looking to replace the sequester in their budget. Time will tell.

THE PRESIDENT: So let me just repeat:  Our economy right now is headed in the right direction and it will stay that way as long as there aren’t any more self-inflicted wounds coming out of Washington.  So let’s keep on chipping away at this problem together, as Democrats and Republicans, to give our workers and our businesses the support that they need to thrive in the weeks and months ahead.

Wouldn’t it be nice if he had said “let’s keep chipping away at this problem together, as Americans, …” rather than “as Democrats and Republicans”?

THE PRESIDENT: Thanks very much.  And I know that you’re going to have a whole bunch of other questions.  And that’s why I hired this guy, Jay Carney — (laughter) — to take those questions.

Thank you, everybody.

I have a question: Where is the President’s specific proposal? At 7:43 AM EST today POLITICO reported:

POLITICO: President Barack Obama will propose a package of short-term spending cuts and tax reforms in an effort to head off the looming sequester cuts Tuesday at 1:15 p.m., a White House official tells POLITICO.

What happened to the “package of short-term spending cuts and tax reforms?” It seems to have died between 7:43 AM and 1:15 PM when the President spoke.

(photo credit: White House photo by Pete Souza)

Responding to Mr. Carney

Responding to Mr. Carney

I’d like to thank White House Press Secretary Jay Carney for giving me so much material to work with in his press briefing today.

MR. CARNEY: Well, there’s a lot in your question, so let me go first to the broader fact, which is that we have seen consistent job growth over almost three years.

Nope. Job growth began in March 2010 and was strong for March, April, and May. We then lost net jobs for four months. We have had continuous job growth since October 2010. That is two and a quarter years, which is not “almost three.” (Source: BLS)

If you start measuring in March 2010, job growth has averaged +141K/month. If you start measuring in October 2010, job growth has averaged +153K/month. If we were at full employment those numbers would be fine because you need around +125-150K/month to keep up with population growth. Given continued high unemployment those numbers fall far short of the job growth rate we need to return rapidly to full employment. We’re generally doing a bit better than treading water, but not much.

MR. CARNEY: But there’s more work to do and our economy is facing a major headwind, which goes to your point, and that’s Republicans in Congress.

This is an aggressive and, I think, novel presentation—labeling Congressional Republicans as an economic headwind. Those same Republicans should respond aggressively to this particular language.

MR. CARNEY: Talk about letting the sequester kick in as though that were an acceptable thing belies where Republicans were on this issue not that long ago, and it makes clear again that this is sort of political brinksmanship of the kind that results in one primary victim, and that’s American taxpayers, the American middle class.

You’re correct that the GDP number we saw today was driven in part by — in large part by a sharp decrease in defense spending, the sharpest drop since I think 1972.  And at least some of that has to do with the uncertainty created by the prospect of sequester.

To the end of your question, I would say that the President has had and continues to have very detailed proposals, including spending cuts, that would completely do away with the sequester if enacted, that approaches deficit reduction — not just the $1.2 trillion called for by the sequester, but even beyond that  — in a balanced way.

His logic is:

  • The sharp decline in Q4 defense spending was in large part responsible for today’s bad (-0.1%) Q4 GDP growth number;
  • The President wants to replace the sequester cuts with a “balanced” package of tax increases and other spending cuts;
  • Republicans oppose the President’s reasonable “balanced” alternative;
  • A recent shift suggests that Congressional Republicans appear to favor leaving the upcoming sequester in place;
  • Therefore the bad Q4 GDP number is because Congressional Republicans refused the President’s reasonable alternative and may be willing now to leave the upcoming sequester in effect.

Problem #1 with this logic is that the President’s proposal would be deficit neutral, so any increase in discretionary spending that helped short-term economic growth would be mostly offset by cuts in other government spending and increases in taxes. If you buy the logic of yanking hard on the Keynesian short-term fiscal lever (big if) then your proposal needs to increase the deficit to get any first order GDP kick. So the tax-increasing solution Republicans are rejecting wouldn’t help GDP growth, it would just shift the components around so that government spending grew faster and private consumption and investment grew more slowly.

Problem #2 is that his sequence doesn’t work. Mr. Carney implies that last quarter’s GDP was harmed by Congressional Republicans’ movement in the past two weeks toward allowing the sequester to take effect. That puts the effect before the cause, which is hard to do.

MR. CARNEY: So it can’t be we’ll let sequester kick in because we insist that tax loopholes remain where they are for corporate jet owners, or subsidies provided to the oil and gas companies that have done so exceedingly well in recent years have to remain in place.  That’s just — that’s not I think a position that will earn a lot of support with the American people.

The words “DEMAGOGUE ALERT” should flash any time you hear the ol’ corporate jet tax break. Eliminating it would raise a few billion dollars of revenue compared to spending problems measured in trillions.

Still, Republicans should find a way to propose repealing this tax break and using the revenue to lower some other tax in a way that both parties like. Neutralize the stupid talking point by getting rid of this tax preference, but don’t use the revenue raised to increase government spending. Don’t wait for tax reform, get rid of this one quickly in the right way.

MR. CARNEY: Speaker of the House Boehner put forward, in theory, at least, a proposal late last year that said he could find $800 billion in revenues through tax reform alone — closing of loopholes and capping of deductions.  So surely what was a good idea then can’t suddenly be a bad idea now.

Did he forget about the $617 B of tax increases that were just enacted? No. This is another important rhetorical trick – suggesting that the previously offered +$800B and the recently enacted +$617B are additive rather than duplicative. I’m certain that’s not how Congressional Republicans think of it. Watch for this rhetorical trick to be repeated often.

MR. CARNEY: The President put forward a proposal to the super committee that reflected the balance that was inherent in every serious bipartisan proposal, including the Simpson-Bowles proposal.  A refusal at the time to allow revenue to be a part of that meant that the super committee did not produce.

Congressional Republicans told me at the time that the Administration was nowhere to be found during the Super Committee’s failed attempts in the fall of 2011.  “Completely disengaged – absent,” was how one insider described the Administration.

Republicans on the Super Committee offered to their Democratic colleagues to accept higher revenue in exchange for either significant entitlement reforms or pro-growth tax reform. Mr. Carney’s claim that Republicans “refus[ed] at the time to allow revenue to be part of that” is inaccurate.

There’s more, but that’s enough for today.

(photo credit: Talk Radio News Service)

More on tax reform: Schumer v. Baucus

More on tax reform: Schumer v. Baucus

Based on some further development and feedback I’m going to update last week’s post on how Senate Democratic plans for the budget resolution interact with the prospects for enacting significant tax reform. My core projection is still quite pessimistic, but I think I have a better feel for the legislative dynamics.

Update: During debate on H.R. 8, the New Year’s tax increase law, House Chairman Camp made clear that he will move through the House a bill that is revenue-neutral (after H.R. 8 took effect). This makes a “preconferenced” Baucus-Camp-Hatch bill highly unlikely, and means that any agreement would come only in a conference after the House had passed a revenue-neutral bill. Such a conference report might or might not be revenue-neutral, but at least the first stage of the process would not increase revenues.

Sen. Schumer’s Senate reconciliation for “tax reform” won’t happen.

A couple of friends pointed out that a Senate reconciliation bill can only be produced by the House and Senate passing identical versions of a budget resolution in the form of a conference report. This means that Senator Schumer’s push last week for a 51-vote procedural path to enacting a tax bill can happen only if the Senate Democratic majority reaches an agreement on deficits, debt, and aggregate spending and tax levels with a Republican majority House. This leads me to four obvious conclusions that I missed in last week’s post:

  1. Senate Democrats can’t force the Senate to pass a partisan tax bill through reconciliation without House Republican acquiescence on creating the process to do so.
  2. Even in the unlikely scenario where House Republicans and Senate Democrats agreed to create such a reconciliation “vehicle” for tax reform, they couldn’t do so unless they also agreed on the other components of a budget resolution: deficit and debt levels, spending and tax aggregates, and the aggregate size of changes to major entitlement programs and discretionary spending.
  3. Therefore, Senator Schumer’s prediction early last week of a 51-vote reconciliation path for Senate passage of “tax reform” has almost no chance of happening.
  4. And if tax reform is even to pass the Senate it will need bipartisan support. For Chairman Baucus this means he needs Finance Committee Ranking Member Hatch early in the process, and House Ways & Means Committee Chairman Camp after/if the Senate passes a bill.

In support of this, I’d note that in a press conference last Wednesday Senator Schumer did not push the reconciliation idea, instead describing it as something that Chairmen Murray and Baucus would work out. I’ll bet that idea is now dead.

Baucus v. Schumer

I think Sen. Schumer [and President Obama] wants the Senate to pass a tax bill that raises aggregate taxes and moves tax policy pretty far to the left. For individuals this would mean different tax preferences based on a taxpayer’s income as well as higher capital gains and dividend tax rates. For firms it would mean higher total corporate taxes, higher taxes on flowthrough businesses (subchapter S firms, LLCs, limited partnerships), and a move toward worldwide taxation of overseas income for C corps. Corporate tax rates would vary based on the type of business—higher for the major oil companies, lower for renewable energy firms and high-tech manufacturing. The tax code would become [even more of] a vehicle for industrial policy and the higher total taxes would finance continued increases in government spending.

Tax reform has traditionally meant broadening the tax base and lowering rates and reducing economic distortions by creating more horizontal equity in which taxpayers in similar situations are treated the same by the tax code. In the Schumer[/Murray/Reid/Obama?] view a new tax bill would introduce as many new tax preferences as it eliminates, it would favor certain industries and firms over others, and it would finance more government spending. That is not tax reform, that’s liberal tax policy labeled as tax reform.

I think Chairman Baucus wants to do bipartisan tax reform while the President and Senator Schumer want to raise taxes on certain individuals and businesses. Those are fundamentally different goals. Chairman Baucus’ path is, in theory, something that could be worked out with his Republican House counterpart Chairman Camp. The Obama/Schumer path leads to partisan stalemate once again.

I also think Chairman Baucus recognizes that Republicans will not agree to large net tax increases. Whatever his own fiscal policy preferences, I think Mr. Baucus knows that a Senate budget resolution that requires a tax bill to raise “too much” revenue will make enactment of a bipartisan tax reform bill much more difficult.

At the same time, I think Chairman Camp may feel a similar degree of flexibility on aggregate revenues. In mid-2011 and even as late as December, the Boehner-led House Republicans were willing to agree to higher total revenues if accomplished through a tax reform bill they liked. Now the policy and political wounds of the recent tax increase law are still fresh, and so while Chairman Camp might still be willing to compromise and agree to higher total taxes, most of his House and Senate Republican colleagues would now reject them, even if they were part of tax reform. I think Mr. Camp would be more optimistic than I am about the additional revenues that could be generated from a pro-growth tax reform (I assume a pessimistic +$100-$150B over 10 years), and he might think that reformed tax code and stronger IRS enforcement could raise revenues without constituting “tax increases” in a traditional sense. Nevertheless, I think he’d have a difficult time rallying Republican support for any tax reform bill that contained a net revenue increase. With the last fight and the new law the President has used up any prior Republican flexibility on total tax levels.

It appears that Chairmen Camp and Baucus are trying to find both an aggregate revenue level and a set of tax reforms where they (and Finance Committee Ranking Member Hatch) can agree. At the same time, their respective caucuses will continue to argue and fight over whether or not total taxes can go up. On the Senate side Budget Chairman Patty Murray and Democratic thought-leader Senator Schumer are staking out the left flank for a likely budget resolution and tax reform stalemate. House Republicans and Senate Democrats are unlikely to pass a common budget resolution, to agree to a common aggregate revenue level for a tax bill, or to create a fast-track legislative process to enact such a bill. Messrs. Camp, Baucus, and Hatch will have to see whether they can substantively agree and build a bipartisan legislative coalition in support of true tax reform after a bruising set of partisan fights on the sequester, continuing resolution, and budget resolution. That will be very hard to do, and it’s why I’m still pessimistic about the prospects for real tax reform.

What to watch

  • Watch Chairman Baucus, who was notably absent from the Reid/Durbin/Schumer/Murray budget press conference last week. Do you see signs that he is arguing (behind Democratic closed doors) for a budget resolution that allows him to pursue bipartisan tax reform? Do you see signs of a Schumer vs. Baucus argument on total tax levels?
  • Watch in-cycle Senate Democrats during the budget resolution process. Are they onboard with the Schumer strategy? Are they OK voting for a budget resolution that raises taxes a lot, given that it’s unlikely to be worked out with the House in a final version?
  • Watch the President, Press Secretary Jay Carney, and Mr. Lew if he’s confirmed. If they support the Murray/Schumer argument instead of the Baucus view, then they are not looking to enact tax reform, but instead to position themselves for what they anticipate will be a[nother] aggressive policy debate that will likely result in a legislative stalemate.
  • Watch for any signs of Camp-Baucus-Hatch cooperation as they try to forge an alliance while being pulled apart by their respective caucuses.

 (photo credit: ajagendorf25)

Tax reform in the Senate

Tax reform in the Senate

Senator Schumer recently said the Senate Democratic majority will pass a budget resolution, in part so it can create a reconciliation instruction to pass tax reform with a simple Senate majority. This is important.

I don’t begrudge the majority for creating that hardball procedural option – we Republicans did it in 2001 and 2003 to enact two rounds of tax cuts. In 2001 we used a reconciliation bill to pass a center-right bipartisan bill 58-33 (Democratic now-Chairman Baucus supported it). in 2003 we used it to pass a Republican-only bill 51-50.

Having a reconciliation vehicle creates the opportunity to pass a bill with a simple majority, but it does not require the bill to be partisan. If Senate Democrats follow this procedural path, they will have to choose between a bipartisan bill (likely Baucus-Hatch) or a partisan Democrat-only bill. The former would be easier to conference with a tax reform bill passed by a Republican House, while the latter would more closely hew to the policy goals of most Senate Democrats and our newly-avowed liberal/progressive President.

The way to tell which they’re going to do is to look at what the upcoming Democratic budget resolution requires tax reform do on total tax levels. If, as Senator Schumer suggests, the budget resolution requires that tax reform increase total taxes by hundreds of billions of dollars (or even a trillion+!) over the next decade, then reconciliation isn’t just an option, it’s their chosen path. Senate tax reform that massively raises taxes will be a partisan positioning exercise that will not lead to a law, and Senate Democrats will need to use reconciliation to block a Republican filibuster. If the President and Senate Democrats want to try to enact bipartisan tax reform, they’ll have to make it revenue-neutral or nearly so.

This didn’t have to be the case.

To my tremendous dismay, in 2011 and 2012 Congressional Republicans repeatedly signaled that they would agree to higher total revenues if they could get tax reform that they liked on microeconomic grounds (i.e., that lowers marginal effective rates on labor and capital). This created the risk that Republicans would agree to higher taxes once in exchange for tax reform, and a second time to get structural entitlement reforms. That’s a lot of potential tax increases, and it scared me tremendously.

While key Congressional Republicans insisted they would only agree to higher revenues resulting from dynamic economic growth effects, I was skeptical about the numbers. In the failed Grand Bargain negotiations of Summer 2011, Speaker Boehner was willing to agree to +$800B in taxes over ten years, as long as those increased revenues were the result of higher economic growth resulting from tax reform that lowered marginal rates. He, and later Republicans on the Super Committee, said they would not agree to “static” revenue increases but they floated the $800B number.

I think you can get maybe $100-150B in higher revenues over ten years from the pro-growth effects of a great tax reform bill. +$800B means you’re agreeing to static tax increases through reform as well. I think that’s terrible policy. You get the benefits of lower marginal rates and a somewhat more efficient economy, but you give them up by having government take more resources from the private sector. In my view that’s almost certainly not worth it, especially when you move from an imagined ideal tax reform to that likely to result from a real-world legislative process in which the efficiency benefits would be tremendously diluted.

The Grand Bargain fell apart in the summer of 2011 because President Obama wanted even higher taxes: +$1.2T over ten years. This discussion repeated itself last month, with the President even more aggressive in his demands for higher taxes. He got about half that amount with his New Year’s tax hike law.

Now the President is signaling that he wants the rest of his tax increases through tax reform, and there’s no way he’s going to get it. Senator Schumer’s comments suggest that Senate Democrats’ priority for tax reform is not making the code more efficient or increasing economic growth, it is raising total tax revenues to finance bigger government.

Agreement on the total level of taxation is a prerequisite for enacting tax reform. In 2011 or most of 2012 Democrats could have gotten some key Republicans to agree to +$800B, if it had been raised the right (pro-growth) way. Now they can’t get that. If Senate Democrats insist that tax reform raises total revenues by hundreds of billions of dollars, tax reform will go nowhere, for five reasons.

First, taxes were just increased by more than $600B. Those Republicans who were willing to support Speaker Boehner’s +$800B will count that +$600ish B against that amount. A few Republicans might in theory still be willing to agree to net revenue increases equal to the dynamic benefits of increased growth, but that’s at most +$100-150B. There is clearly no Republican appetite for net increases measured in hundreds of billions of dollars (this pleases me). Senate Republicans would block such a bill if they could, necessitating the reconciliation bill which could not be filibustered. But even if Senate Democrats pass it on a party-line vote, House Republicans will not agree to further tax increases beyond maybe +$100-150B, and then only if they really like the pro-growth incentives in a reform bill. They probably won’t even go above revenue-neutral because of reason #2.

Second, the President’s end zone dance and partisan taunting during and after the New Year’s tax increase law should convince even the most bipartisan and cooperative of Congressional Republicans that the political risk/reward tradeoff of working with the President on tax reform is poor. Bipartisan tax reform only has a chance if members of both parties can see both a potential policy win and a shared political win at the end of a long and winding road. President Obama has demonstrated repeatedly that he views fiscal politics as partisan and zero sum. For a Camp-Baucus-Hatch tax reform bill to come together, which is the only feasible path to enacting a new law, you need a legislative environment conducive to bipartisan cooperation. Thanks to the President’s framing of the last tax law we have exactly the opposite.

Third, a partisan path for Senate Democrats makes Finance Chairman Baucus’ job much harder. He will not have the bipartisan cover essential to repealing or reforming the popular broad-based tax preferences like the mortgage interest subsidy, the health tax exclusion, the deductibility of charitable contributions, and deductions for state and local taxes. If you want to move the policy needle you need to tackle these big items, and you can’t do that and succeed without bipartisanship to protect you from the political blowback of taking on such popular preferences.

Fourth, a partisan path means Mr. Baucus has a smaller universe of potential votes to work from. Sure he’d only need 50 (+ the VP), but corralling 50 of 55 votes on tax reform is hard and may be impossible. It’s much easier to try to find 50 votes out of 100, even if 20 conservatives of those 100 are practically ungettable. In committee any one of his 11 Democrats could hold a bill hostage if Republicans are unified in opposition.

Finally, tax reform that raises taxes creates far more losers than winners. That increases citizen and interest group opposition and makes it even harder to get the votes needed to pass a bill. Democrats may like the prospect of spending an extra trillion dollars but I’ll bet they can’t find the votes for the specific tax increases to raise that much, especially if they’re simultaneously trying to sell tax reform as helping taxpayers.

Senator Baucus knows all of this. Whatever his personal policy preferences, he has to know that a budget resolution that instructs him to enact tax reform that raises hundreds of billions in higher taxes will not lead to a law, but instead at best to a partisan stalemate in which he is the face of a liberal bill that represents the views of a quite liberal Senate Democratic caucus. It’s almost impossible for him to pass such a bill out of the Senate. If he does it’s almost impossible to conference with the House.  And either way it won’t help his reelection prospects in low-tax Montana this election cycle.

If you are interested in the prospects for tax reform, watch the public postures of the key Senate Democratic players on total tax levels in the budget resolution. The people to watch are Finance Chairman Baucus, Budget Chairman Murray, and Leader Reid. Also watch Senators Durbin and Schumer and incoming Treasury Secretary Jack Lew if he is confirmed.

If in their budget resolution Senate Democrats require that tax reform raise total taxes by hundreds of billions of dollars or more, then tax reform will at best be an interesting contrast in partisan approaches between Senate Democrats and House Republicans, and at worst a partisan flame-out in which the Senate fails to pass a bill or doesn’t even try.

If instead the moderates (and Chairman Baucus?) force the budget resolution to create a reconciliation instruction for revenue-neutral tax reform, or tax reform that only raises revenues by $100-$150B over ten years from dynamic growth effects, then the prospects for significant and bipartisan tax reform in the next two years increase from “hopeless” to “extremely unlikely.”

Sorry to be so pessimistic.

(photo credit: Office of Senator Baucus)


A modest debt limit strategy

A modest debt limit strategy

I agree with Speaker Boehner (in this excellent interview in today’s WSJ) that spending cutters’ principal legislative leverage comes from the March sequester and continuing resolution deadlines rather than from the upcoming need for a legislative debt limit increase. I disagree with those who argue that Congressional Republicans must therefore simply pass a clean debt limit increase as the President requests. I’d like to present an alternate debt limit strategy, one which is both responsible policy and potentially effective in making modest progress in cutting government spending.

My substantive view is that the debt limit must be legislatively increased. It is highly irresponsible to pursue a legislative strategy that places the full faith and credit of the U.S. government at risk. Failing to pay debt obligations is at least an order of magnitude more damaging than a “government shutdown” induced by failing to extend a continuing resolution. Having lived through the 1995 government shutdown, I wouldn’t want to wish that on anyone, but I’d happily risk another shutdown rather than roll the dice on the debt limit.

At the same time, despite President Obama’s jaw-dropping argument to the contrary, we have a government spending problem that must be addressed. If your teenager breaks the borrowing limit on a credit card you gave him, you don’t fix the problem by refusing to pay the bill. But you also don’t let him keep spending at such an irresponsible rate. You pay the prior obligations and you simultaneously force him to change his spending habits.

President Obama and his team are working overtime to frame a “clean” debt limit extension, without any accompanying spending cuts, as the responsible policy path. That is an outrageous argument. Look to Europe: Germany and its northern European neighbors repeatedly loan Greece enough cash to make it through the next few quarters and they require policy reforms as a condition of that loan. They then repeat the process frequently. Sure, Greece would like a large long-term loan with no conditions, but their creditors know that path would lead to no reform and ever-increasing debt.

The responsible policy path is to increase the debt limit and to cut government spending. It is not to increase the debt limit, with vague promises about maybe cutting spending in the future, if it is done the right way and only if it is accompanied by even more tax increases.

But if a debt limit must be enacted, if we cannot risk a default, then how can Republican spending cutters exert leverage on a President who doesn’t want to cut spending?

Most observers mistakenly assume that the only way to force the President to change his spending habits is to threaten to block a debt limit increase. But in addition to other, better levers like the impending spending sequester and the expiring continuing resolution, there are smaller levers that can change how a debt limit law is enacted without killing the necessary increase. These levers are not strong enough to force the President to accept a fundamental shift in spending trends, but they can be leveraged to enact significant incremental spending cuts.

There are three key tactical levers.

  1. All Members of Congress hate voting to increase the debt limit. It is one of the most politically painful votes a member can cast.
  2. Traditionally the majority party in each House delivers the bulk of the aye votes for a debt limit increase. The minority party free rides and most vote nay.
  3. When there’s a legislative disagreement over the size and duration of a debt limit increase, the smaller/shorter increase always wins.

It’s hard to overstate how much Members hate voting for a debt limit increase and how entitled House Democrats feel about not having any obligation to do so because they’re in the minority. That is the soft spot we’re going to exploit—catching the President between his policy goals and the political self-interest of his partisan allies, especially in the House.

I’ll propose this alternate strategy in the form of a hypothetical joint public statement by Speaker Boehner and Senate Minority Leader McConnell.  The 50 vote number below can, of course, be dialed up or down.

Hypothetical press statement by Speaker Boehner and Leader McConnell

SIM-SPEAKER BOEHNER: I want to begin by assuring you that we will not allow the government to default on its obligations. The debt limit will be increased. The questions we must resolve are first, whether we will simultaneously cut government spending and second, who will cast the votes for the debt increase.

The President says he wants a clean debt limit increase without any accompanying spending cuts. I am prepared to bring such a bill to the floor and deliver 50 Republican votes for a three-month clean extension. If they wish to avoid spending cuts, the President and Leader Pelosi simply have to deliver the other 168 votes from House Democrats for a short-term clean extension. I will not block such a bill, and will even deliver up to 50 Republican votes needed to put it over the top. But if the President chooses this path, his party will have to deliver the overwhelming majority of the House votes, and he’ll get only a short-term extension. Then we’ll repeat this exercise three months from now and three months after that.

SIM-LEADER MCCONNELL: If the House were to pass such a bill, Senate Republicans would not filibuster it, but they also would not vote for it. It would have to pass the Senate entirely with Democratic votes.

SIM-SPEAKER BOEHNER:  If the President and Democratic leaders want a longer extension than three months, or if they want more than 50 House Republicans and no Senate Republicans to vote aye (so they don’t have to twist as many Democratic arms to cast a very unpopular vote) then we need to cut government spending as well. If we match one dollar of spending cuts for each dollar of debt limit increase, then I’m prepared to deliver the bulk of the needed votes on the Republican side and do an increase that lasts up to a full year. Under this principle bigger spending cuts lead to a longer debt limit extension. Tomorrow the House majority will pass just such a bill, a responsible bill that both increases the debt limit and cuts government spending. We will pay our bills and we will take a significant step toward solving our underlying government spending problem. [Remember, this is all hypothetical.]

We Republicans see ourselves as representing the government’s creditors, the taxpayers who finance government spending. We will make sure the government does not default.  But we’re not going to provide the votes for a long-term credit extension without reforms and regular checkpoints. If the President wants more borrowing without taking responsible action to cut spending, his party will have to deliver most of the votes in the House for such a bill, and they can explain to their constituents why they think we should keep borrowing without solving the underlying fiscal problem. And they can do this every three months for the foreseeable future.

In the House we’d be willing to increase the debt limit for longer than a year if it is matched dollar-for-dollar with spending cuts, but only with a verifiable commitment from Senate Majority Leader Reid and Senate Budget Committee Chairman Murray that the Senate will pass a budget resolution this year and next.

Repeating myself, the House will not allow the government to default. Tomorrow the House majority will pass a bill that raises the debt limit and cuts government spending. If the Senate instead raises the debt limit without cutting spending, then I will bring the bill to the House floor and deliver 50 Republican votes for it, as long as it’s not more than a three-month extension.  If the Senate sends us a clean long-term extension, we’ll just send it right back to them.

The President and his party have a choice. They can have clean short-term debt limit increases without spending cuts, passed every three months almost entirely by Congressional Democrats. Or they can have a longer-term debt limit increase simply by cutting government spending and passing budgets in the Senate.

Either way, the President will get his debt limit increase, and the U.S. government will meet its financial obligations. But if he and his party are not going to cut spending, then they will have to carry the responsibility of unrestrained additional borrowing, and they will have to repeat this exercise every few months.  It’s the President and his party’s call.

The above strategy requires significant tactical and message coordination among House Republicans, possibly more than they are currently able to execute. But if they had such coordination they could create modest leverage on the debt limit bill while pursuing responsible policy. They could combine this with far greater leverage from threatening to kill a continuing resolution and to allow the spending sequester to bite.

Rather than threatening enactment of a debt limit increase, this strategy attacks the President’s tactical political weakness. The President wants a debt limit increase, but his Democratic colleagues (especially in the House) expect they won’t have to vote for it. By turning this assumption on its head, this strategy would tell the President, “Hey, if you want your terrible policy, you’re going to have to deliver House Democratic votes for it. Good luck with that.” Either the President accepts and Republicans pound on the “Democratic debt limit increase” message every three months, or he agrees to cut spending. Either way, default risk is eliminated. Republicans will look responsible because they will be acting responsibly, and the markets couldn’t care less about which Members take political heat for casting these unpopular votes.

But the Members care. A lot.

(photo credit: Aaron Smith)

The venue shifts

The venue shifts

A few days ago Speaker Boehner redirected his focus from negotiating an ad hoc Obama-Boehner deal to a more traditional legislative path. Since the Speaker announced plan B at the beginning of the week, the venue for substantive negotiations has shifted from Obama/Boehner to a standard House/Senate dynamic. If the House passes a plan B-like bill soon, I expect that redirection will be complete. This shift is a silver lining to a very dark cloud.

The venue shifts

This venue shift has three important effects.

  1. The venue shift narrows the negotiating scope. Spending cuts, a debt limit extension, and a CPI correction will be deferred until 2013 (notwithstanding Team Obama’s recent petulant claim that they won’t deal with it next year). The scope is now limited to tax changes, with unemployment insurance, a sequester delay, and a Medicare doc fix possible, more likely in separate legislation, but still done this year. Extension of the President’s payroll tax provision is less likely. His infrastructure spending never had a chance in the first place.
  2. The venue shift moves Senate Majority Leader Reid to the forefront of negotiations and moves the President back into a secondary if not a supporting role.
  3. The venue shift makes a legislative solution in 2012 more likely.

For weeks I have been struggling to see a substantive policy sweet spot in the Obama-Boehner negotiations that I thought could be supported by the President and the Speaker and could pass both the House and Senate. I am still skeptical that such a sweet spot exists, largely because I think the President won’t agree to big enough cuts in entitlement spending growth.

In contrast, it is easy to see a sweet spot between the plan B bill the House may soon pass, and S. 3412, which Senate Democrats passed last summer. I don’t know that this new regular order will lead to a solution, but at least there is a clearly visible path to success. The legislative process that begins with a plan B bill is, in effect, plan A. I don’t think there’s another path that has a better chance of successful resolution before year end.

We can see evidence of the venue shifting as Senate Democrats today debate amongst themselves about what their position should be on the House bill. No matter what definition of “rich” they choose, the news is that they are making their own decision, independent of that defined by the President.

Leader Reid enters the spotlight

Assuming the House passes a bill soon, all eyes should turn to Leader Reid. Be wary of his confident statements about what the Senate will and won’t pass. Nobody can possibly know this right now. Leader Reid can only know what he alone will or will not do. He can guess at his colleagues’ behavior, but when he asserts “The Senate will not pass X,” he is bluffing.

He can, however, unilaterally decide what bill the Senate will or will not consider. He can choose not to bring up a House-passed plan B bill, and he can choose not to try to send the Senate-passed bill from July to the House. He can unilaterally choose to have the Senate not act, but if he initiates the legislative process of considering a bill, then all bets are off.

Leader Reid’s challenge is that his standard tactic, not legislating and deferring to the President to negotiate with Republican leaders, is probably unsustainable if the House passes a plan B bill. Leader Reid’s key decision will be if and after the House has passed a bill. Will he sit and do nothing, in an attempt to try to force Speaker Boehner to resume negotiations with the President? Or will he move to proceed to a bill on the Senate floor? If he does the former, then Senator Reid is still acting as the President’s lieutenant, and is trying to keep the Senate in the background. If he begins to legislate, then he is acting as the Senate Majority Leader and he is taking the reins from the President.

The President’s struggle for relevance

As Leader Reid moves to the forefront, the President fades to the background. The driving question changes from “What policies does the President want?” to “What policies can we get enough votes for in the House and Senate?” Until now Congressional Democrats have been drafting behind the President. Speaker Boehner’s move forces Leader Reid to decide whether to continue following President Obama as he takes everyone off the cliff, or instead help Senate Democrats chart their own path to a new law, allowing the President to lead from behind.

I interpret everything I hear from the White House this week as part of a furious struggle to stay relevant. I think the President and his team were surprised by the Speaker’s move, and now they fear being sidelined. Yes, Dan Pfeiffer made a veto threat against the plan B bill yesterday, but the plan B bill will never make it to the President’s desk unchanged, so that veto threat is irrelevant. If it gets to the President’s desk, it will have been modified by negotiations with Senate Democrats, and that particular veto threat won’t apply.

The Obama-Boehner broader substantive talks are dead for 2012. I don’t think the Speaker could restart them even if he wanted to. He and his fellow Republican leaders have invested too much effort into getting House Republicans to support their new path. They can’t change direction again without risking a major revolt. It appears the President and his team either don’t recognize this or they don’t care. As long as Team Obama continues to talk about their failed bigger deal, and about the need to restart talks with the Speaker, they are not contributing to a speedy and successful legislative conclusion. They may, however, be instead investing now in publicly framing a future legislative failure.

Even if Leader Reid were to refuse to take up a House-passed bill, and even if President Obama were today to accept Speaker Boehner’s most recent offer on a bigger deal, there isn’t time to negotiate all the secondary and tertiary details, many of which are as difficult to negotiate as the top-tier stuff. The Obama-Boehner negotiating process has simply run out of time.

A secondary role for the President does not mean that he is irrelevant, or that he won’t become involved again late in the game. It means instead that he is, in effect, acting through Leader Reid. This limits his ability to influence the final product.

This looks to be a colossal negotiating foul-up on the President’s part. Did he never anticipate that the Speaker might go with regular order as the deadline approached and the President continued to play stall-ball?

The sweet spot

I think the following bill could pass the House and Senate before the end of the year.

  • All tax rates below $700K of income are extended permanently as they are now.
  • Above $700K, tax rates revert permanently to their pre-2001 rates: 39.6% for income and dividends, 20% for capital gains;
  • the Personal Exemption Phaseout (PEP) and Pease limit on itemized deductions are not reinstated; and
  • the AMT is permanently patched.

In addition, I think a separate bill or bills pass to:

  • extend unemployment insurance in some form;
  • patch the Medicare “doc fix” for another year; and
  • delay or mitigate the spending sequester for 6-12 months.

In the current vernacular this is the Speaker’s plan B bill but with a $700K income threshold rather than $1M, plus separate bills on UI, doc fix, and the sequester.

I think such a bill would lose votes on both ends of the spectrum, and everyone would complain about something that should be in the bill but isn’t. But I think this bill could pass both houses.

And then, despite all of his current bluster, the President would sign it, in large part because a bunch of Democrats voted for it.

Off the cliff?

It is still quite possible that there will be no new law this year. The greatest threats at this point are House conservatives, Leader Reid, and the President. If we go off the cliff, it will likely be because one of three things happened:

  1. House Republican leaders couldn’t start the process by passing a bill with only Republican votes;
  2. After receiving a House-passed bill or bills, Leader Reid refused to initiate the legislative process; or
  3. President Obama failed to recognize the venue shift and said things to make legislative regular order harder, in a failed and futile attempt to restart the Obama-Boehner talks.

If President Obama were to stay quiet, and if Leader Reid were to bring up a soon-to-be House-passed bill, offer his own substitute amendment, and allow 3-5 relevant amendments per side, this thing would get done.

My prediction

  • 50% chance the sweet spot or something quite close to it becomes law before the New Year begins;
  • 48% chance there’s no new law;
  • 1% chance I’m fundamentally wrong, the Obama-Boehner grand bargain talks restart, and a deal comes together before the New Year; and
  • 1% chance the Mayans had it right, the world ends tomorrow, and we no longer care about the fiscal cliff.

(photo credit: Center for American Progress Action Fund)

What kind of negotiator is President Obama?

What kind of negotiator is President Obama?

President Obama’s behavior over the past month is consistent with three different models, and I cannot figure out which one applies.

In model 1 the President is a risk-taker. He is a competent and effective negotiator who is willing to risk a recession and the ensuing political blame game in January because he thinks both will help him achieve his fiscal policy goals. I don’t think the President is willing to take such a risk, but Michael Barone makes a convincing case otherwise. You decide.

In model 1 the President has leverage because he is willing to go where Congressional Republicans are not (over the cliff).

In model 1 the President would, in the last few days of December, compare Speaker Boehner’s last offer with what the President thinks he can get after a few weeks of January blame game, then decide whether or not to accept the offer or take us over the cliff.

In model 2 the President is bluffing quite effectively. He is risk averse, and he is also a savvy, patient, and skilled negotiator. Privately he knows that he cannot allow a no-bill scenario because a recession would seriously damage his second term. But he has bluffed Congressional Republicans into thinking he is willing to take that risk, and this bluff has given him tremendous leverage. His initial offer was outrageous but designed for maximum press benefit over the next few weeks. He will demonstrate to a willingly gullible press corps that he is reasonable by showing the significant negotiating concessions he has made (from an absurd starting point) in an attempt to get a deal with those extreeeeme Republicans.

In model 2 the President continues to leverage Congressional Republicans’ fear of being blamed for no bill to press them for incremental concessions without giving up anything meaningful in exchange. Yet the President would, at the last minute, accept Speaker Boehner’s last offer, because the President is also quite afraid of a no-bill scenario. We would never know that he was bluffing since there would be an agreement and a bill.

In model 3 the President is an unskilled and ineffective negotiator who cannot or will not close a deal with those eeeevil Republicans. In this model the President does not want to go over the cliff, he is genuinely afraid of a recession, and he thinks he is a savvy and skilled negotiator who is bluffing Republicans. But he fails to understand what Speaker Boehner needs to support a final deal, or he doesn’t care and is unwilling to give it to him. Or he fails to realize how hard this kind of legislative deal is to pull together, and he mistakenly thinks he can sit with his arms folded until the last minute and then it will all suddenly, magically come together.

In model 3 President Obama doesn’t know how to compromise or isn’t capable of it. He knows only win and loss.

Model 3 could arise from overconfidence: “You are more afraid of no bill than I am, so you have to do whatever I say” (not recognizing that Republicans have a third option available).

Model 3 could arise from a sense of entitlement, “I won, the people voted for me and I campaigned on this, so I should get my way, and you must give it to me.” But Speaker Boehner is not negotiating for himself. He is an agent, negotiating on behalf of 240 House Members and 47 Senate Republicans, and he is therefore limited in his ability to agree to certain things. There may be no overlap between what President Obama feels he deserves and what Speaker Boehner can or is willing to deliver.

Or model 3 could arise from a zero-sum mentality, an inability to understand that an agreement requires both sides be able to label a deal as a win. We know the President is an effective political combatant and candidate, and we have seen him be ruthlessly attack those with whom he disagrees.

Unlike his predecessors, President Obama has not achieved any positive-sum legislative compromises with the other party. His only major deals with Republicans were the extension of all tax rates two years ago and the summer 2011 budget deal. The President now defines both of those laws as mistakes and losses rather than as honorable compromises. He sees and frames them as the results of zero-sum negotiations in which Republicans forced him to accept bad policy outcomes. And now when he has leverage, he thinks and hopes he can turn the tables, not recognizing that he still needs Speaker Boehner and House Republican votes.

President Reagan did Social Security and tax reform deals with Democrats. President Bush 41 did a budget deal and the Americans with Disabilities Act with Democrats.  President Clinton did NATFA, and welfare reform, and a balanced budget with Republicans. President Bush did the 2001 tax cut, No Child Left Behind, Medicare, two energy bills, and TARP with Democrats. Each President defined these deals as success, as principled compromises, and both parties shared the credit.

President Obama has not negotiated a single win-win middle ground legislative compromise with the other political party. I fear he may not know how to do so or be unwilling to do so because he sees all his dealings with Congressional Republicans as pure zero-sum.

The scary part about model 3 is that the President might unwittingly kill an agreement, further inflame a nasty partisan blame game, and trigger a recession even though in this model that’s not the outcome he wants. In model 3 a different negotiator (say, Mr. Bowles) could find a middle ground that could pass both the House and Senate, but President Obama cannot or will not. Some combination of legislative inexperience, a distaste for interacting with Congress, and a naturally combative rather than cooperative temperament may hobble the President’s ability to close deals with those who have different policy priorities. And if model 3 is correct, in the next few weeks it could all go sideways because we have a President who doesn’t know how to or isn’t willing to negotiate.

It may be impossible for us to know which of these models applies to President Obama. I know this is an important question, and that a clear answer would not only allow us to analyze the current negotiation, but would increase the ability of other elected policymakers to deal effectively with the President over the next four years.

(photo credit: White House photo by Pete Souza)


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