House Democrats’ practical transition to minority status precedes the formal transfer of power on January 5th. Speaker Pelosi has one big decision to make before she becomes Minority Leader: Will she bring up a Senate-passed tax bill for an up-or-down House vote?

Procedural summary

On Thursday the tax deal was released in legislative form, surprisingly labeled the Reid/McConnell amendment. You don’t see that every day on a big economic issue. Senate Republican Whip Kyl supports it, and in the Senate we therefore have an Obama-Reid-McConnell-Kyl alliance. That’s unbeatable and will clearly get the 60 votes needed for cloture next Monday at 3 PM EST.

• Bill text
• Joint Tax Committee score. (Note that this excludes the unemployment insurance, which should have a roughly $56 billion cost.)
• Staff summaries: Democratic staff (Senate Finance?), Republican Camp-Grassley memo

Assuming the Senate invokes cloture Monday afternoon, I would expect the bill to pass no later than Tuesday. It then crosses the rotunda to the House, where Speaker Pelosi has a decision to make. She has unilateral authority to decide which bills come to the floor of the House. Technically 218 House members could overrule that authority using a discharge petition, but that takes at least a month, less time than is left in this Congress.

The Speaker’s choice

Yesterday the House Democratic Caucus held a non-binding vote in which they rejected the tax deal. Speaker Pelosi issued a carefully worded statement after the meeting which reads, in part:

In the Caucus today, House Democrats supported a resolution to reject the Senate Republican tax provisions as currently written. We will continue discussions with the President and our Democratic and Republican colleagues in the days ahead to improve the proposal before it comes to the House floor for a vote.

While it’s amusing to see her describe the Obama-Reid-McConnell bill as “the Senate Republican tax provisions as currently written,” the key language is “We will continue discussions … to improve the proposal before it comes to the House floor for a vote.”

She did not say “The bill in its current form must be changed before it comes to the House floor to a vote,” nor “I will not bring this bill to the House floor for a vote in its current form.” You should be forgiven for thinking her statement meant that, but she could have said that if she had wanted to tie herself to the mast. She did not.

In legislative parlance the Speaker is about to be jammed by the Senate. Her options are (a) bring a bill to the floor that her caucus hates and watch it pass and become law; or (b) take sole responsibility for stopping the bill, almost certainly until next year.

Jamming is when you use the legislative process, often at the end of a session, to limit someone else to a yes-or-no decision in which yes is painful and no is even worse because you get blamed for killing something popular. The Speaker and House Democrats want to escape from this binary choice, to gain leverage to change the bill to their liking. Their options for generating that leverage are:

1. House Democrats defeat the Senate-passed bill;
2. House Democrats amend it and send it back to the Senate;
3. or the Speaker refuses to bring it up for a vote.

I don’t think House Democrats could defeat this bill on a straight up-or-down vote. I expect a large number of Senate Democrats will vote aye, influenced by the President, Leader Reid, and extender tax goodies contained within the bill. A big Senate Democratic vote count makes it harder for a House Democrat to vote no. Almost all House Republicans will support it. While the average voter among House Democrats opposes this bill (as we saw from yesterday’s Caucus vote), I’m fairly certain the marginal House Democrat will be an aye.

The Speaker and House Democrats would almost certainly prefer to amend the bill and send it back to the Senate. This is in their power to do (if they can unify), but I expect that doing so would face solid Senate opposition and therefore fail. It would go something like this:

Speaker Pelosi & House Democrats to Senator Reid: We’re going to improve this bill and send it back to the Senate.

Senator Reid to Speaker Pelosi: I like your improvements. Let me check with Senate Republicans.

Senator McConnell to Senator Reid: No. We have a deal with the President and you and we’re not changing it.

Senator Reid to Speaker Pelosi: McConnell said no. My hands are tied. I made an agreement with him that I can’t break. Even if I could, there’s no way I can get a modified bill through the Senate before we adjourn. McConnell will filibuster it and it will die in the Senate. I can’t accept that.

Speaker Pelosi & House Democrats to Team Obama: Mr. President, will you help pressure Senator Reid?

Team Obama to Speaker Pelosi: We’d love to help you, really we would. <snicker> Can’t. Senator Reid is right, we can’t overcome a Republican filibuster. If we had more time there might be a way to overcome that, but we must get this done before the end of the year.

Speaker Pelosi & House Democrats: $&^$@#(@*&^!

This means that, if Speaker Pelosi and/or the majority of her caucus want to kill this bill, she’ll have to do it by refusing to bring it to the House floor. That’s an impossible position for her.

If she brings the Senate-passed bill to the floor for a vote, in her last major legislative effort as Speaker before transitioning to minority status, her caucus will split on (what they perceive as) a massive legislative defeat on a top-tier issue. When you’re a legislative party leader, your caucus splitting is very, very bad. On an issues like this it’s a disaster.

If she still refuses to bring the Senate-passed bill to the House floor, then Congress will adjourn for the year and she (not House Democrats, but she, Nancy Pelosi) will be solely responsible for rejecting the broadly bipartisan bill. She will be responsible for tax increases on all income-taxpaying Americans beginning January 1, in opposition to a bill supported by the President and Congressional Republicans.

This is what it means to be jammed. We’ll see what she does.

(photo credit: Dennis Wilkinson)

Liberal House Democrats and their outside allies are railing at President Obama for his tax deal with Congressional Republicans. This anger is misdirected. Let’s examine the President’s three basic bad options for a post-election negotiating strategy, and a fourth option that would have allowed the Left to win on taxes.

Option 1 – Cut a deal with Republicans in 2010

The key element of this strategy is “in 2010.” Negotiations occur with the outgoing Congress and while Rep. Pelosi is still Speaker.

For the President this strategy did not risk the harmful policy effects of tax increases on January 1 or the political blame that would accompany them. It clears the decks of the 2010 agenda, allowing a fresh start in the State of the Union address. Rep. Pelosi is still be Speaker during the negotiations, providing a small tactical advantage.

At the same time, by setting a deadline and explicitly avoiding a veto fight, the President gave up negotiating leverage.

Shortly after Election Day the President chose this option when he said he intended to resolve this issue in 2010. At that moment my hopes for a good outcome spiked upward.

Option 2 – Wait until 2011. Veto the Republican bill and sustain the veto. Then negotiate a deal with Republicans.

Since Democrats would still have the Senate majority, this strategy would have required Leader Reid to allow some Democratic members to vote for such a bill and to get his liberals not to filibuster it. The President would say something like, “It’s clear Republicans aren’t going to negotiate until I have proven that I will veto their bill, so let’s get that behind us.”

At least initially this strategy would have energized the Left. The veto might create more Presidential strength in subsequent negotiations with Republicans, possibly leading to a better policy outcome for Democrats. Each side would have demonstrated it can block the other’s first choice outcome (Rs through a filibuster, Ds through sustaining a veto).

But tax rates would increase on January 1, hurting workers and their families, slowing economic growth, and initiating full-fledged blame game. January 2011 would be dominated by a 2010 tax fight with an unclear outcome, rather than by the New Obama Agenda, whatever that may be.

I think the President rejected this option because he correctly calculated that Republicans would be procedurally and politically stronger in 2011. Speaker Boehner and House Republicans could pass their preferred bill and send it to the Senate, increasing their leverage in negotiations.

A weaker hand in negotiations and the policy and political damage of January 1 tax increases made this option unpalatable to the President. He said this in his bizarre press conference on Tuesday, and his aides say it in almost every press story.

Option 3 – Let taxes increase on January 1 and blame Republicans. Sit tight and wait until Republicans cave to the political pressure created on both parties by higher taxes.

This option would have been a gamble that Republicans would cave to the economic policy damage and political pressure resulting from tax increases on January 1. Both sides of the negotiation would be accepting short-term policy and political pain for potential long-term policy benefit.

A liberal House member from a safe district might calculate that this tradeoff is worth it. The President faces different incentives. He is held responsible for the national economic situation, and he would take the brunt of the blame for short-term damage caused by a stalemate.

In addition, I think Congressional Republicans convinced the President they were more willing to sit tight than he was.

Option 4 – In early 2010, pass a budget resolution conference report that creates a reconciliation bill for the President’s preferred tax policy.

Congressional Democrats had this fourth option back in the Spring of 2010. This is the partisan path that would have eliminated Republicans’ ability to block the Democrats’ preferred policy. With a simple majority of the House and Senate, Democrats could have had a complete policy win.

The budget resolution is a concurrent resolution that is not signed by the President. The failure to pass a budget resolution and create a reconciliation bill is entirely a failure of the Legislative Branch.

Even better for the Left, the budget resolution (had there been one) could have provided protected reconciliation status only for tax changes of a certain deficit size. Congressional Democratic Leaders could have precluded the additional $700 B deficit effect of the Republicans’ preferred alternative. Thus the Democratic-preferred alternative would have needed only 51 votes in the Senate, while the Republican-preferred policy would have needed 60. That’s the margin of victory.

Unlike with health care, this would have been a straight-up-the-middle use of the reconciliation process. Republican procedural complaints would have been much less effective than during health care.

There are few downsides to this option, other than the routine annual challenge of making other hard budgetary decisions needed to pass a budget resolution.

Astonishingly, this year Congressional Democrats didn’t even try to pass a budget resolution. At the time I criticized them for irresponsibility and a failure to govern. Now we see a policy ramification of this failure.

When earlier this year I asked Republican friends still on the Hill why they thought Congressional Democratic leaders didn’t choose this path, most shrugged. I would have bet heavily in their favor had they taken this route. I am happy they made this mistake, and I’m mentioning it only now, when it’s too late for them to execute it.

Assigning responsibility for the outcome

One can debate whether the President should have pursued options 2 or 3 instead of 1, but option 4 trumps all of them. The President is responsible for the strategic mistake of elevating a center-right issue to the top of the agenda in an election year, but he bears only secondary responsibility for the legislative outcome.

Speaker Pelosi, Majority Leader Reid, and their Budget and Tax Committee Chairmen are responsible for missing the opportunity last spring to choose the reconciliation path in option 4. Had they done so, the Left would have won on taxes.

(photo credit: Wikipedia – Pelosi Reid)

Terms of the deal

Here’s what I understand the deal to be:

• Extended for two years, through December 31, 2012:
  • All 2010 individual income tax rates;
  • 2010 capital gains and dividend rates (15%/5%);
  • Expanded Earned Income Credit is extended for two years
  • Expanded child credit is extended for two years
  • “American Opportunity” (education) tax credit
  • Alternative Minimum Taxes as in the McConnell bill, such that no additional taxpayers face AMT
• Estate and gift taxes return, with a $5 million per person exemption and a 35% rate. After 2012 they would revert to pre-Bush levels ($1 M / 55%)
• Full expensing of business investment for all non-property investment for all businesses made between September 8, 2010 and December 31, 2011. 50% expensing for investment made in 2012.
• Extended unemployment insurance benefits are available through December 31, 2011.
• Two percent payroll tax credit for 2011 (employee side, replaces the refundable Making Work Pay credit)
• The smorgasbord of “extender” provisions will run for two years, which is retroactive for 2010 and prospectively for 2011. Details on this are still TBD and are undoubtedly occupying nearly every tax lobbyist in town. (ick)

Analysis

Given a Democratic President, this is the best possible deal that could be reasonably expected. For the next two years, through the remainder of President Obama’s first/only term, tax rates won’t go up on anyone except dead people. (OK, actually their heirs.) That is a total and complete policy win.

With almost no political effort and very little public discussion, capital tax rates aren’t going up. I had expected Congressional Republicans to get two years on all the individual rates but was nervous about the capital tax rates. That is a slightly surprising and complete policy win.

The estate & gift tax deal ends up at the Kyl/Lincoln compromise levels, as most anyone could have guessed for a while. While this isn’t a complete victory, it’s darn good.

The stupid Making Work Pay credit, which the President mislabeled as a tax cut, is now a true payroll tax cut. That’s a marginal improvement.

Unlike many Congressional Republicans, I support extending extended unemployment insurance benefits when the unemployment rate is this high. My back-of-the-envelope suggests that, at a 9.8% rate, between four and nine people who would like a job but cannot find one are getting more generous UI benefits for each person who is getting those same benefits and choosing not to take a job. I’m OK with that ratio.

If I could make two changes to the bill, I’d pay for the increased spending on unemployment insurance with spending cuts in the outyears, and I’d drop the accounting gimmick that doesn’t lower future Social Security obligations to account for the lower payroll tax revenues.

If I could make a third change, I’d drop the business expensing. This provision is a timing shift – it will cause firms to accelerate their medium-to-long-term investment spending into 2011. That’s good for 2011 growth but bad for 2013 and 2014 growth. Since I accept the consensus predictions that we’re in a multi-year slow recovery, that’s not a constructive change. There are times when this makes sense. I don’t think this is one of them, but I’m open to opposing arguments.

And while the small extenders are mostly icky special interest provisions, I’ll hold my nose on these once again, at least for now.

These are, however, relatively minor complaints. This bill is an enormous policy win because the effective changes actually go beyond 2012. Along with the actual changes to law through 2012, this bill should change your expectations of rates beyond 2012. By far the most likely legislative scenario in 2012 is that we repeat this whole scenario and go another 2-4 years without raising taxes. All the arguments that were effective in 2010 will be as effective in 2012, and Congress will already have cast this extension vote once. The tax rates, in effect, become just another “extender” vote. At the moment I’d give 4:1 odds against these rates increasing in 2013.

Compared to what?

I’ll guess that some conservatives will complain that both the rate cuts and the payroll tax cut will have only limited supply-side growth effects because they are temporary. Some may then get sloppy and say “temporary tax cuts don’t create growth.”

Yes, they do, they just don’t create as much growth as permanently lower rates. Permanently lower rates are better than lower rates for two years, but lower rates for two years are better than higher rates beginning 24 days from now.

For many higher income earners the 2% payroll tax cut reduces their average but not their marginal tax rate. I could design a package of income tax rate cuts that I’d prefer to the 2% payroll tax cut, but so what? It’s silly to compare this bill to any one person’s ideal tax policy and say it’s inadequate. This is legislating, not a theoretical tax seminar.

And isn’t letting people keep more of their wages a good idea even if for some it doesn’t have a big supply-side effect?

For those concerned with the deficit increase associated with the UI benefits, I agree that’s a problem. On the upside, the President’s Labor Day proposal to increase highway spending by $50B – $100B just became a lot less likely, as the business expensing provision with which it was packaged is being enacted here.

Recommendation

No-brainer. Support the deal.

(photo credit: FaceMePLS)

In a blog post at the Wall Street Journal, James Freeman writes:

But George W. Bush is making a less credible claim, now that reducing federal spending is a top voter concern. Mr. Bush is currently portraying himself as a spending hawk, with a chart in his new memoir showing that federal spending averaged just 19.6% of GDP during his tenure. This appears to make Mr. Bush a more responsible spender than predecessors Bill Clinton, George H.W. Bush, and even Ronald Reagan.

Nowhere in Decision Points does President Bush refer to himself as a “spending hawk.” He does write:

Despite the costs of two recessions, the costliest natural disaster in history, and a two-front war, our fiscal record was strong.

I drew a different conclusion than Mr. Freeman did from the President’s book. Throughout Decision Points and this section in particular, I read President Bush as providing context to explain the decisions he made, rather than trying to make particular claims or classify himself.

Despite his post’s title, “George W. Bush’s Fuzzy Math,” Mr. Freeman does not dispute the math or the facts in President Bush’s book. He instead argues for a different way of measuring a President’s fiscal record.

The undisputed facts are:

• Average federal spending was a smaller share of the economy during the George W. Bush administration than during each of the Clinton, George H.W. Bush, and Reagan administrations.
• The same is true for taxes. Average federal taxes were a smaller share of the economy under our 43rd President than under our 40th, 41st, or 42nd.
• Of the four, President Clinton’s deficits were smallest, almost entirely because his revenues were highest. President George W. Bush had the second-smallest deficits of the four.
• The budget deficit during President Bush’s tenure averaged two percent, below the fifty-year average of three percent.

My conclusions: Relative to the economy, the federal government was smaller during the Bush Administration than under any of its three predecessors, and his deficits were small by historic standards.

Based on data provided by a frequent critic of the President’s, Mr. Freeman looks only at the change in the level of spending from the day the President took office to the day on which he left. He ignores baseline trends and the role of Congress and assigns full responsibility for the change between those two endpoints to the President. He uses these two points to compare President Bush unfavorably to Presidents Reagan and Clinton, because spending declined on their watches while it increased on President Bush’s.

Mr. Freeman applies President Obama’s “inherited” meme to federal spending, arguing that Presidents Reagan and Clinton deserve credit for reducing spending from even higher levels when they took office. He writes, “Even with a Democratic House, Mr. Reagan managed to cut spending as a percentage of GDP from 23 to 21.” Spending when President Reagan took office in 1981 was 21.7% of GDP. With a Democratic House and a Republican Senate, it grew to 23.5% in 1983, then declined to 21.2% in 1988. Mr. Freeman gives President Reagan credit for the decreases but no blame for the increases. Yes, spending declined over Reagan’s tenure, but by 0.5 percentage points, not by two points as Mr. Freeman suggests.

Yes, federal spending increased over President Bush’s tenure. The biggest increases were for defense and homeland security. While critics often focus on the $50 billion in increased Medicare spending for drugs in 2008, they ignore the much larger $350 billion in increased baseline Social Security and Medicare spending from 2000 to 2008. President Bush took political risks to propose specific changes to significantly slow the growth of both Social Security and Medicare spending. These proposals were largely ignored by Congress.

And yet even at its highest point during the Bush tenure, spending as a share of GDP was still lower than the lowest year of the Reagan Administration. Should we give Reagan credit for the slight decline and blame Bush for the increase, or should we say the Bush years were better because government was smaller?

Mr. Freeman’s approach broaches an interesting question: should we measure a President based only on the change between a President’s first and last days in office, or instead on the average levels over the full term, which incorporate both policy changes and the starting point for those changes, and which look at the full eight years rather than at just the endpoints? This debate should seem familiar: for 21 months President Obama has argued that his policies have made things better than they otherwise would have been, while the American people have rejected his policies because the results were inadequate. If President Obama leaves office in 2013 with unemployment at 8 percent, slightly lower than in his first full month of office, the endpoint logic suggests we should judge him an economic success because unemployment declined. I think we should instead compare the average unemployment over President Obama’s tenure with President Bush’s average of 5.3 percent and President Clinton’s average of 5.2 percent. I think that citizens care more about about average levels over time more than about the changes measured between arbitrary political endpoints.

It is also difficult to judge the “responsibility” of enacted changes objectively because observers differ on the appropriate counterfactual. The Medicare drug benefit President Bush campaigned on, proposed, and signed into law increased entitlement spending. To determine whether that is responsible or not, should we compare the increased spending to (a) no Medicare drug benefit, (b) the more expensive Democratic alternative, or (c) President Bush’s initial budget-neutral proposal, rejected privately at the time by House and Senate Republican leaders?

As we see from the ongoing debate on extending the Bush tax policies, the subjective choice of a baseline for comparison can lead to radically different conclusions about the budget effects of a proposed policy change. By choosing a helpful counterfactual, President Obama makes his proposal to extend $3.1 trillion of tax policies appear responsible and “cost free,” and argues the Republican proposal to extend $3.8 trillion of tax policies is an irresponsible “cost” of $700 billion. The numbers in Decision Points describe final levels rather than changes. President Bush thereby avoids entirely the subjective debate about counterfactuals.

I wish that we (in the Bush Administration) had been enable to convince multiple Congresses to enact more of the spending cuts proposed by President Bush. While President Bush’s critics frequently remind us of his decision to fulfill a campaign promise to add a drug benefit to Medicare, they forget or ignore his important fiscal policy moves in the other direction. President Bush vetoed the second farm bill; that veto was overridden. President Bush twice vetoed bills unnecessarily increasing spending for children’s health insurance. President Bush repeatedly proposed hundreds of billions of dollars of Medicare and Medicaid savings, only to find these proposals routinely ignored by Congress. President Bush proposed a long-term budget neutral drug benefit plus Medicare reform package to House and Senate Republican leaders in 2003. Those leaders supported the drug benefit but rejected the savings from the aggressive structural reforms. President Bush received little support for Social Security reform proposals that would have significantly addressed our long-term entitlement spending problem. If you don’t like the net spending increases during President Bush’s tenure, ask why Congress so often resisted the President’s proposals to cut spending.

Unlike each of his three predecessors, President Bush did not raise taxes.

George W. Bush, a wartime President, had a smaller federal government and lower taxes relative to the economy than each of his three predecessors, historically small deficits, no tax increases, and 5.3% average unemployment. He vetoed a farm bill and two health bills for spending too much. He proposed structural and incremental reforms to Social Security and Medicare that set up the current entitlement reform debate. Maybe the conventional wisdom should be revised a bit.