President Obama to Face Into the Fiscal Cliff, Mitt Romney Exits Stage Left

The Defining Moment of the President's Second Term
Perhaps the most important moments of President Obama's second term will actually come before his second term officially begins.

The negotiations over the so-called "fiscal cliff" will represent the most critical decisions around tax and spending policy that have been made in 20 years.

A combination of President Obama's Health Care legislation, the nature of some of the temporary tax cuts enacted as part of the stimulus (and later extended) and the expiration of the (once extended under Obama) Bush tax cuts, have led the law to converge to where the following things will automatically happen on December 31st or January 1st, absent action from Congress and the President:

* Expiration of the Bush-era tax cuts for all income levels.  Income rates at the low end of the income spectrum would rise from 10% to 15% and at the top end from 36% to 39.6%.
* With expiration of the Bush-era tax cuts, qualified dividend taxes would increase from the present level of 15% to normal income tax levels (up to 39.6%).  Additionally, capital gains taxes would rise from 15% to 20%.
* Inheritance taxes would return to pre-Bush levels.
* Social Security taxes would return to their "normal" levels, a 2% tax increase from the reduced rates of the past 2 years, enacted as part of the stimulus and then extended.
* An additional 0.9% earned income tax on incomes over $200K for individuals and $250K for married couples would be enacted, raising their total income tax rate to 40.2%.  This was part of the health care legislation.
* An additional 3.9% dividend and capital gains tax would take effect for individuals with incomes over $200K and married couples with incomes over $250K.  The combination of this and the Bush-era tax cuts expiring would increase dividend taxes for top earners from 15% to 43.5% and on capital gains from 15% to 23.9%.
* Alternative minimum taxes would revert back to their 2000 levels, essentially wiping out the effectiveness of tax deductions and exemptions for the upper-middle class and above.
* Extended unemployment benefits would end, meaning that the current 73 weeks of extended unemployment benefits available to the long-term unemployed would be reduced to 26 weeks, taking millions out of the benefit.
* Approximately $65B in cuts in defense and $65B in cuts in non-Social Security entitlements and discretionary spending would automatically be enacted.

That's a massive number of tax increases and spending cuts all set to take place at once.  According to the Congressional Budget Office, total taxes from 2012 to 2014 would rise by $774B.  Total spending would stay essentially flat, rising by $33B with a 7% reduction (before inflation) in discretionary spending offset by a 5.9% rise in entitlement spending, spurred by the continued growth in Social Security and Medicare outlays.

In net, the deficit would fall to $387B from $1.128T in just two years, a dramatic reduction and the lowest deficit as a percentage of GDP since the Clinton surpluses and well below the long run average of the Carter, Reagan and first Bush administrations, even after factoring in the potential for a mild recession in 2013 as a result of all the money being sucked out of the system.

The fiscal cliff is actually not bad economic policy - it essentially amounts to finally taking our medicine and paying our bills.  And it seems almost certain not to happen, because no one seems to have the guts to take the consequences of paying our bills all at once, particularly with the significant impacts to middle-class tax payers and the recession potential.

There are 4 plausible scenarios that I see for resolution of the fiscal cliff:
(1) Kick the Can Down the Road
I think this is the most likely scenario.  With only 6 weeks to work, the potential for a compromise that all sides can live with seems unlikely, particularly in a highly polarized Washington.  A bill that averted all or most of the provisions of the cliff for 4 or 6 months, to give the parties more time to work seems likely.
(2) Let It Happen
This, in many ways, is my favored choice, but seems the least likely to happen.  I can envision a scenario where the President digs his heels in on taxes for top bracket payers and House Republicans dig their heels in on not extending anything until the President gives on that issue.  It would be a policy that no one in Congress is advocating, but it has a small possibility of happening.
(3) A Grand Bargain
Congressional Republicans have indicated some willingness to increase revenues so long as tax RATES don't go up.  The President could cut a more revenue neutral deal that caps or eliminates deductions for higher income earners but does not raise rates, in exchange for what Republicans really want, which is deeper discretionary cuts and reforms to Medicare.  I could see a deal where deductions phase out about $200K, the Bush era rates are maintained, domestic cuts are made and Medicare retirement age is raised by a couple of years.
(4) A Partial Compromise
Perhaps they will split it all down the middle.  Top rates go up, but not as much as Obama wants.  Middle and lower class tax cuts are maintained.  Spending cuts are made but not as much as Republicans want.  And entitlements go unreformed.  After kicking the can down the road, this seems like the second most likely scenario.

Whatever happens will have to happen before the end of the year, so it will happen with the old congress and technically during the President's first term.

The End of the Romney Era
When John Kerry lost to George W. Bush, he got to go back to the Senate and chair the Foreign Relations committee.  He is in the running for President Obama's second term cabinet, being among the reported final 3 to run the State Department.

When John McCain lost to Barack Obama in 2008, he also returned to the Senate and became a voice for Republican deficit hawks and neo-conservative foreign policy.

Not since 2000 have we had an election where the loser is likely to fade completely from the political scene.

You see, while Mitt Romney has been running for President for the better part of the past 8 years, he has no post to go back to.  He is clearly no longer the leader of the Republican Party and has no elected office to return to.  There is much that he can do in private life, Al Gore has certainly taken the opportunity to leverage his celebrity for the personal cause of global warming, but it was odd for me to think that after 8 years of seeing Romney on TV virtually every week, he really has no place in either politics or the Republican Party.

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