Before the end of this year, American lawmakers must decide whether to extend current tax rates, implement deep spending cuts as well as to raise the nation’s legal debt limit. Because of the heavily negative impact that failure to act will likely have on the economy, the event is referred to as the “fiscal cliff.” Yet there’s a good chance that Congress will let the United States go over it.
On the tax side, lawmakers can either extend George W. Bush era income tax rates or let these “cuts,” which were enacted in 2001 and 2003, expire in accordance with the laws that established them.
Democrats favor extending the current rates for incomes under $250,000 dollar but raising taxes on the wealthy. Republicans want to preserve all the Bush tax rates.
Because Republicans have the majority in the House of Representatives and Democrats control the Senate, both parties can hold the process hostage to their demands.
Congress will also have to vote on extending President Barack Obama’s payroll tax credit and several other deductions and lowered rates that were set in previous years. In total, failure to act on Congress’ part would trigger $440 billion in tax increases next year which could stifle necessary business expansion to reduce employment.
On the spending side, more than $100 billion in cuts loom as a result of “sequestration,” the process of automatic spending reductions that was set into motion last November when Congress failed to identify at least $1.2 trillion in cuts to ten year spending projections. The sequestered cuts are split equally between domestic programs and defense.
Republicans, Secretary of Defense Leon Panetta as well as military officials insist that the latter cannot move forward. General Martin E. Dempsey, the chairman of the Joint Chiefs of Staff, warned in February that under sequestration, he would have to cut spending on maintenance, operations and training to an “unacceptable” extent. “That’s the definition of a hollow force,” he said.
A bipartisan agreement on watering down the scheduled spending cuts will likely be easier to reach than a deal on tax rates. The fact that any attempt to find compromise will come amid a debate about raising the nation’s debt ceiling complicates will likely complicate the effort.
Republicans last year refused to raise the limit on the government’s borrowing ability unless spending reductions were enacted to shrink the deficit. This year, the federal government must borrow $1.3 trillion on a $3.8 trillion budget. The national debt has increased by $5 trillion under Obama’s presidency. Democrats remain wary of spending cuts while Republicans are opposed to tax increases.
Most Republican congressmen and senators have pledged to their constituents not to raise taxes. The only way for them to agree to a comprehensive deficit reduction effort without violating their pledge is to let the fiscal cliff happen and then vote for tax changes.
The tax increases, after all, are written into current law. Allowing them to happen wouldn’t be voting for a tax increase. It wouldn’t require a vote at all.
Few political observers expect an agreement on spending and taxes to be reached before the general election. The subsequent “lame-duck” Congress, which won’t yet include newly-elected representatives and senators, could pass legislation to stave off the fiscal cliff. The outcome of the election will determine whether the emphasis in a future deficit reduction effort is on spending or taxes.
If Barack Obama wins reelection or Democrats maintain their control of the Senate, the two parties will have to work together so a combination of spending cuts and tax increases would be likely. If Mitt Romney wins the presidency and Republicans secure a majority in the Senate as well, they could seek to shrink the deficit through spending cuts alone while actually reducing tax rates which they believe will help economic growth.