Small steps are enough
Agreement to resolve 'fiscal cliff' crisis has been derided by some, but small deals over time will still go some way to cutting the US budget deficit
The just-in-time budget deal the US Congress passed on New Year's Day calls to mind Samuel Johnson's observation about dogs that walk on their hind legs: "It is not done well; but you are surprised to find it done at all."
The same could be said of US lawmakers. For more than a year, the conversation in Washington focused on achieving a Platonic grand bargain to overhaul the tax code, reform entitlement programmes and reduce the national debt.
Bloomberg's editorial board supported a compromise that would trade Medicare reforms for higher tax rates and a tax code overhaul. It would have been grand if the package sent this week to President Barack Obama accomplished even a bit of that. It doesn't; Congress is too polarised to reach such a deal.
Still, this week's agreement doesn't deserve the derision it's getting from some economists and fiscal policy experts.
For now, Congress has found enough common ground to defuse a US$600 billion fiscal time bomb, no easy feat considering the divided government and the deep ideological differences between the parties. The combatants will have to summon the courage to do it again in two months, when the Treasury will have depleted its borrowing authority, the deadline for stopping US$110 billion in automatic spending cuts arrives, and the law that funds the government expires.
At that point, with the United States on the verge of default, a painful sequestration and a government shutdown, we'd love to see the elusive "grand bargain". But another round of successful small deals will suffice, thank you.
One of the agreement's biggest lessons was that cross-party personal relationships matter. When Obama and House speaker John Boehner failed to work out a deal after repeated attempts spanning 18 months, Senate Republican leader Mitch McConnell turned to Vice-President Joe Biden. The two 70-year-olds served together for about a quarter of a century in the Senate, almost always on opposite sides of the issues yet never forgetting the validity of the other's political imperatives or point of view. In less than two days, they worked out the deal which Congress adopted.
"Simply put," said Jared Bernstein, the vice-president's former chief economist, "they remember a day when politicians compromised".
The agreement's economic effects could surprise the naysayers. It sensibly retains some short-term fiscal stimulus while increasing revenue in the long run. The measure, for example, extends unemployment insurance for about two million jobless people whose benefits have ended. It also continues refundable tax credits for low-income families and students at university.
True, the payroll tax cut was allowed to lapse. Its absence could pull more than US$100 billion out of the economy this year and is the primary reason an estimated 77 per cent of taxpaying households will face higher levies this year.
But losing the 2 percentage point tax break, which was never meant to be permanent, is a small price to pay for avoiding income tax increases for more than 99 per cent of taxpayers.
Obama can take pride knowing that the agreement improves inequality somewhat. The burden of higher taxes will fall hardest on the top 1 per cent, and particularly on the top 0.1 per cent, of income earners. Those making more than US$2.7 million will pay an average of US$443,910 more this year, or 26 per cent of the additional burden, according to the bipartisan Tax Policy Centre. Households with income between US$500,000 and US$1 million will pay an average of US$14,812 more.
With the federal government having hit its debt ceiling, Republicans hope to replay their 2011 demand that debt-limit increases be matched dollar-for-dollar with spending cuts. Obama laid down a "no hostages" marker on January 1 when he said future deficit-reduction deals must balance spending cuts with further tax increases. At the same time, Obama said he's open to compromise. Medicare spending can be reduced, he said, perhaps by limiting the cost-of-living increases.
Obama's offer is a good place to begin the next round of negotiations. Now it is House Republicans' turn to name the revenue raisers they can accept, or the spending cuts they want.
Congress already made more than US$1 trillion in spending cuts in 2011. An additional US$1.2 trillion could be saved or raised later this year. When added to the just-concluded pact, the total could come close to US$3 trillion in spending cuts and tax increases over the coming decade.
Deficit reduction in fits and starts is still deficit reduction.