Senate Averts “Fiscal Cliff,” Long-Term Budget Deal Elusive

Lawmakers avoid an immediate tax hike but achieve no long term fiscal consolidation.

The United States Senate voted early Tuesday morning to extend low tax rates for the vast majority of Americans while raising taxes on the rich, thus averting the worst of the “fiscal cliff” that could have plunged the world’s largest economy back into recession.

The bipartisan deal, hammered out by Vice President Joe Biden and Republican leader Mitch McConnell late Monday night, lets tax cuts on individual incomes over $400,000 expire and phases out tax deductions and credits for incomes as low as $250,000 which was the threshold President Barack Obama originally set to raise taxes on.

The Democrat, who was elected to a second term in November, campaigned on making the wealthy pay their “fair share” toward deficit reduction.

The Congressional Budget Office estimates that the tax hike on high incomes as well as the expiration of a payroll tax cut will yield some $620 billion in revenue over the next ten years.

The Senate agreement, which has yet to pass the House of Representatives where opposition Republicans are in the majority, does little toward long-term deficit reduction, however. Rather it might widen the shortfall as the expiration of all of the tax cuts that were enacted in 2001 and 2003 by President George W. Bush and extended last year would have brought in far more revenue. The law also extends unemployment insurance for some two million Americans for a year and postponed for two months $109 billion in spending reductions that would have come into effect automatically as a result of the Budget Control Act of 2011.

That act was the result of negotiations about raising the nation’s debt ceiling and scheduled automatic budget cuts unless the two parties in Congress managed to find alternative ways to reduce the deficit. They didn’t but few lawmakers want these automatic spending cuts, which equally affect defense and domestic programs, to go forward.

Even if the House accepts the Senate proposal to eliminate or at least postpone the austerity measures of the fiscal cliff, members of Congress have little time but to resume budget talks because the government hit its debt ceiling on Monday, the amount it can legally borrow, currently set at $16.4 trillion. The Treasury will be able to make payments for another two months, for instance by suspending the reinvestment of federal workers’ retirement account contributions in short-term government bonds, giving the legislature until late February to prevent the United States from defaulting on its debt obligations.

Republicans are likely to use the debt ceiling debate as leverage to extract deeper spending cuts from Democrats. The Biden-McConnell agreement is only a short-term solution to an enormous long-term problem.

For the last four years, the United States government has run deficits over $1 trillion. The national debt has doubled in the last six years. Major entitlement programs, including health care for the elderly and poor and public pensions, are headed for bankruptcy unless they are reformed within this decade. Combined with food stamps, Supplemental Security Income and unemployment insurance, the federal government spends more than two-thirds of its budget on such social security programs.

Comprehensive entitlement and tax reform is needed for fiscal consolidation in the long term but Democrats are reluctant to cut social spending while Republicans oppose tax increases.