Our Elected Leaders Punt Yet Again On Real Deficit Reduction, Boehner Narrowly Holds On To Speaker Job, Christie Goes Ballistic

The Fiscal Cliff Deal Isn't Much of a Deal at All
I guess there are things that all sides can claim victory in the fiscal cliff "deal" that was negotiated early in the new year, which was primarily a by-product of discussions between Vice President Joe Biden and Senate Minority Leader Mitch McConnell.

For Republicans, they can feel good that for 99.2% of Americans, the tax cuts that President Bush pushed for in 2001 and 2003, that the vast majority of Democrats and even some Republicans opposed at the time, have no become a permanent reality.  They are law forever.  They can also feel good that the military cuts that were part of the sequestration deal last year are now put off, albeit for only two months.  They can also feel good that they will get another bite at the spending apple in short order with the pending fights over the second half Fiscal 2013 budget and the debt ceiling coming up directly.

For Democrats, they can feel good that they successfully raised taxes on the wealthiest 1% (actually the wealthiest 0.8%, to be precise, but you get the point), that they averted the fiscal cliff cuts for domestic programs, albeit for only two weeks, that unemployment insurance was extended for another year, that renewable energy tax credits were extended for another year and that they really didn't have to agree to any spending cuts to get the deal done.

As for me, I don't feel particularly good about any of this.

Let's introduce a reality into the equation.  The deficit last year was $1.128 trillion.  We took in $2.435 trillion in taxes, 46% from individual income taxes, 35% from Social Security and Medicare Taxes, 10% from Corporate Taxes and 9% from the miscellaneous set of other federal taxes that the government collects, such as excise taxes on gasoline, cigarettes, alcohol, permitting costs, etc. We spent $3.563 trillion, 45% on Social Security and Medicare/Medicaid, 23% of Defense and Military expenses, 10% on unemployment and other income security measures (such as subsidized school lunches), 6% on interest on the national debt and 16% on everything else.

So what did the fiscal cliff "deal" do?  It allowed the temporary payroll tax reduction on Social Security to lapse, which effectively boosts Social Security payroll tax income by 19%, since the total tax (including both employer and employee) rises from 10.4% to 12.4%.  This raises about $120B per year in additional revenue, versus the last two years.

The cliff deal also raised income taxes from 35% to 39.6% for individuals making over $400K and married couples making over $450K and raises capital gains and dividend taxes on those individuals from 15% to 20%, as well as capping deductions on those over $200K/$250K.  Collectively, this raises about $60B per year in additional revenue.

So, all else being equal (and it is obviously not because not everything else is static, but everything else is pretty well in balance), we took a $1.128 trillion deficit and solved 16% of it.  On the 2012 basis, this woud give us about $2.615 trillion in revenue, not quite enough money to fund Social Security, Medicare/Medicaid, Defense and interest on the debt, if you cancelled every single other government program (no FAA, no SEC, no EPA, no FDA, no USDA, no OSHA, no federal court system, no power at the White House, etc.)

In other words, this was a totally and grossly insufficient bill to solve the structural problem that we had.

It amazes me that Democrats now accept 99.2% of the Bush tax cuts that they once opposed, and that we have never been able to afford.  It also amazes me that they reject out of hand even the most modest GOP proposals to rain in entitlement spending, such as shifting the chained CPI for Social Security increases, which would save a ton of money over time and make the system much more stable while having only a gradual effect on today's seniors. 

It also astonishes me that the GOP continue to fight for low taxes without a serious, specific proposal on how they would cut spending.  Since today's revenues don't even cover Defense, Entitlements and Interest and they want even lower revenues than today, to be credible to me, they would need to present a budget that makes deep, deep cuts in Defense and Entitlements to even get close to balance.  They have not, as of yet and, in fact, most have strongly opposed defense cuts, while skirting the issue of entitlements.

Let's not forget also the underlying dynamics that make the future budget reality worse.  The population is getting older and health care costs are still rising (albeit the rate of health care inflation has slowed from the pace of the past decade) so entitlement costs will rise faster than revenues.  Interest rates are at 200 year historic lows, meaning that it is highly probable that interest rates and therefore interest expense will rise in the future, especially with a rising federal debt.  There are some positives - unemployment insurance costs are likely to drop as the economy improves along with some other social programs and the wind-down in Afghanistan will save some on the military budget.  But in balance, the trajectory is towards a worse budgetary situation, not a better one.

Both parties to date are taking unserious positions.  There are only four levers to manage our current situation:
(1) Raise Taxes of Some Form in Meaningful, Broad Way
You can't tax the 1% and get us into balance.  To make a meaningful impact on the deficit, you would need to raise taxes on the majority of the population in some form, either in the form of higher income tax rates, higher payroll taxes or a national sales or VAT tax.
(2) Structural Reforms to Entitlements
Higher participation ages, lower benefits, etc.  You have to "bend the curve" on entitlement spending.
(3) Meaningful Cuts to Defense
We spend 5 times the next nearest country (China) on our military.  Would we be unsafe at 3 times their spending?
(4) Default in Some Way Shape or Form
This is a nuclear option that would cause a depression.  There are two ways to do this - either simply don't pay the bills which would be an utter disaster to financial markets that would immediately spark a deep financial and economic crisis or print money to pay the bills (i.e. have the fed buy up and forgive treasury debt),  which would likely spark hyper-inflation.  Neither of those options is at all appealing, even compared to 1-3.

My other disappointment (or maybe I should be happy, since I didn't love the deal) with the cliff deal is that it doesn't really solve anything.  The federal budget still expires March 1st, so there is another, immediate fight over spending.  Sequestration cuts still hit March 1st also.  And, approximately the end of February, the federal government won't be able to pay its bills unless congress increases the debt ceiling.  In other words, get ready for more melodrama, stern rhetoric and down-to-the-wire posturing that solves nothing before another 11th or 12th hour deal that doesn't do nearly enough.

My final disappointment is in President Obama's inability to lead or paint a vision.  He wasn't even a participant in most of the talks that cut the deal.  He has painted no clear vision for how we get where we need to go with the budget and seems to have no sense of urgency about reducing the deficit.  Joe Biden showed far more leadership that the President in this case, and even Biden's leadership was just to cut a deal in the end, not to really solve the problem.

Prepare to be disappointed again in the coming year.

Boehner Holds On With 2 Votes to Spare
John Boehner will be the House Speaker for the next two years, after successfully beating back dissent from about 8% of his caucus.  While there was no Republican actively running against Boehner, a cast of 17 Republicans (excluding Boehner, who did not vote, as is tradition) either cast protest votes, voted "present" or did not vote.  Some were clear protest votes, for the likes of Alan West (who isn't in the House any more as he lost re-election) and Colin Powell (who has never been in the House), some were semi-serious votes, including 3 for Majority Leader Eric Cantor, who many of the far right view as more sympathetic to their cause than the pragmatic Boehner.  Boehner needed an outright majority in order to not force a second ballot on the issue, which required 218 votes.  The 220 he received was sufficient - barely, to keep him with the Speaker's gavel for the next two years.

All of this supports what I have long said about Boehner - he is a conservative but not a wing nut as many think.  He is hemmed in by a caucus that is well outside the mainstream.  The fact that he almost lost his Speakership simply for supporting the deal he did speaks volumes about where the right-wing in the House sits.  Heck, a significant number of House Republicans even opposed the Hurricane Sandy aid package that was finally passed on Friday (more on that in a second.)

My advice to Boehner?  You know you are never going to be the darling of the right wing, so take your re-election as an opportunity to try to go solve the problems.  The hard-liners will hate it, but they already don't support you.  So cement your legacy and get something done.

Chris Christie Lets Loose on the House GOP
The fiscal cliff deal on January 2nd was the last thing the outgoing House of Representatives did before disbanding to make way for the new House, which was sworn in yesterday.  This greatly upset lawmakers from New York and New Jersey, who had been hoping for and believed they had secured agreement for aid for the battered coastal areas impacted by Hurricane Sandy.

Why the House didn't take the issue up before disbanding is inexplicable to me.  Perhaps John Boehner couldn't swallow asking his conservative members to vote on a spending package right on the heels of a painful vote on the fiscal cliff.  But, come on, when did relief for people made homeless by a hurricane become a partisan issue?

Christie was specific, and named names in his criticism, stating:
"There is only one group to blame for the continued suffering of these innocent victims, the House majority and their speaker, John Boehner."

Boehner scrambled to pull a vote together on the bill, with an initial aid package rapidly set for a vote yesterday and the balance to be voted on January 15th.  The initial package passed the House 354-67, with all 67 "no" votes coming from Republicans.  It is shocking to me that there were 67 members of the new House majority willing to vote no on this bill.  The bill passed the Senate, which always seems much more reasonable an bi-partisan, without a single "no" vote.

The initial aid package contained only $9B, the bigger $51B package is to come in the January 15th vote.  Could that package be in serious jeopardy, given the delay and vote on the first bill?  If it is, it would be utter political suicide for the House GOP.  Nothing makes you look like a wing nut like pushing hard to keep tax cuts on capital gains for people making millions of dollars and then opposing federal funds to help people made homeless by a hurricane.

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Let's All Go Cliff Diving But Please Don't Mess With the Federal Debt Limit

So, it certainly appears that we are headed over the fiscal cliff (kind of a misnamed and bad analogy if you ask me...modest across the board tax hikes and spending cuts are hardly a "cliff", but I'll go with the commonly understood language), barring an eleventh hour deal.

There are a few ways that things could still play out differently - Speaker Boehner could decide to allow a vote on extending lower tax rates for those below $250K, which seems almost sure to pass with near universal Democratic support and a smattering of Republicans who think that something is better than nothing.  I could also still see a "kick the can down the road" type of bill that delays the sequestration.

But frankly, I'm happy to go cliff-diving.  It'll be fun to watch the federal deficit shrivel up to a fraction of its former self overnight.  We'll actually be living within our means (or closer to it) when the cliff happens.

Alas, it will almost surely be temporary.  President Obama is no doubt looking ahead to January 3rd, when the new Congress goes into session and he has more House and Senate seats to work with.  He still obviously won't have a majority in the House or the 60 seats to stop a filibuster, but the difference between having to win over 17 House Republicans instead of 25 and 5 Senate Republicans instead of 7 will make a difference in how good a deal the President can get.

Regardless, we will survive a few weeks of Clinton-era tax rates, fragile economy and all.

The meatier issue staring us in the face is the debt-ceiling, which the country is scheduled to hit on Monday.  There is a little time on the clock - similar to last year, the Treasury can buy some time by not making pension contributions and delaying paying for other expenditures - typically these tricks can buy about two months, although they will likely buy longer than that if we also go over the cliff and borrowing needs are a lot less.

Coinciding with the debt ceiling issue is the issue of the remaining budget for Fiscal 2013.  The continuing resolution that everyone agreed to in order to avoid this showdown at election time covered funding of the federal government through March of 2013.  Beyond that, new legislation will need to be passed.

I mention these two issues together, because it poses an obvious question - why are Republicans threatening to mess with the debt ceiling again?  They have control over what we spend beyond March.  The House can choose to pass much smaller appropriations, if it deems fit to do so.  Charge less on the credit card if you wish, but quit threatening not to pay the bill.  The whole notion that congress can refuse to permit the debt that is necessitated by laws it passed seems absurd every time it comes up.  And failure to raise the debt ceiling will have much more severe consequences over the long term than going over the fiscal cliff for a few weeks.

Let's hope rational heads prevail and it doesn't come to another default showdown.  But given the history, anything is possible.

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The GOP is Playing a Very Bad Game of Chess - But Does That Mean Anything for a Cliff Deal?

December has not exactly been the GOP's proudest moment.  They have been out-flanked every step of the way by the Democrats and have looked disorganized, unreasonable and even downright silly.  Two events cap how badly they have navigated the fiscal cliff debate:
(1) McConnell Filibusters Himself
President Obama, as part of one of his offers on the cliff, had proposed as part of the resolution, that Congress do away with the need to periodically increase the debt ceiling.  The President's thinking was - Congress has to authorize all of the actual expenditures that lead to a debt-ceiling hike being necessary in the first place, so the vote is redundant and all it does is create conflict and risk the US credit rating.  The GOP, of course, has no desire to give up leverage on the debt ceiling, which they hope to use to extract additional spending cuts, including entitlement reform.

Hoping to embarrass Obama by showing how little Democratic support his proposal hid, Mitch McConnell proposed a bill that would permanently eliminate the cap on the debt ceiling.  His thinking surely was that Democrats in the Senate were not ready to sign off on such a bill.  The only problem is that they absolutely were and Senate Majority Leader Harry Reid moved quickly to vote to pass the bill.

All of this put McConnell in the position of realizing that this bill that he has proposed, but opposed, would actually pass.  McConnell promptly filibustered a vote on his own bill in order to kill it.  That's right, HE proposed the bill, then filibustered it.

That's a high score on the stupid-meter if I've ever seen it.

(2) Boehner Better Get a Plan C
There is no doubt about the going-in GOP position to the negotiations - that they didn't want any income taxes to go up (they were less worried, as far as I can tell, about payroll taxes going up, but income tax rates were critical.)  The House has already passed a bill, essentially with only GOP votes, to extend all of the tax rate cuts at all income levels.

Realizing that there was no way that the President was going to sign off on such a bill and that he would likely slam the GOP for holding middle-class tax cuts hostage to tax cuts for the very wealthy, Boehner rallied this week around a "Plan B" - a plan to extend tax rate cuts for everyone under $1 million in income.  Surely, he must have thought, if the President vetoes that bill (or the Senate refuses to take it up), it will be the Democrats who will be blamed for holding middle class tax cuts hostage, since he would have compromised and agreed to let rates rise for the richest.

There was only one problem with Boehner's plan - his own caucus didn't support it.  Boehner had to suddenly cut bait and not even vote on the proposal yesterday, after it became clear it would fail broadly in a floor vote.

So the GOP is clearly is disarray at the moment, and the polls reflect this.  His approval rating is up to 56% in the Gallup poll (and at similar rates in other recent polls), the highest in over 3 years.  A solid majority (52%) believe that the GOP needs to give more on the fiscal cliff, while a much smaller minority (40%) believe that the President hasn't given enough.

All of that said, I don't know how this will play out.  Knowing how badly they've fumbled and that the nation is uniting against their point of view, the GOP should give ground.  A conservative friend of mine, certainly no fan of the President or the Democrats (he told me the last time he voted for a Democrat was a state senate race in Virginia in 1988), put it very clearly - "we had an election over this.  We lost.  We need to get over it."  But the modern GOP is a complex animal.  Certainly Boehner and the mainstream Democrats in the Senate from purple states (see John McCain or the departing Scott Brown) want a deal.  But the Tea-Party loyalists who won primary battles on the basis of their ideological purity, may not care a whiff that the public is against them.  If they can't even get behind a $1 million+ rate hike increase, what are the odds that they can support a deal that the President can live with?

The best chance for a deal is a coalition of most of the Democratic party with the most moderate elements of the GOP.  Until the new House is sworn in come January, there are only 193 Democrats in the House, with 218 votes needed to pass a compromise, meaning that any deal that attracted all of the Democrats would need 25 Republican votes.  Realistically, any deal that attracted significant GOP support would likely lose some Democratic support from the far-left, so a more realistic scenario might be a deal that say wins all but 20 of the Democrats and wins 45 Republican votes.  Such a deal would require some hard selling in the House by Boehner and Pelosi.

In the Senate, assuming the deal is not deficit-reducing and subject to reconciliation, which is a safe assumption since the "base case" of going over the fiscal cliff is likely far more deficit-reducing than anything that will be agreed to, you would need all the Democrats and Democratic-leaning Independents plus 7 Republicans to break a filibuster.  There are a lot more moderate Republicans in the Senate, so this seems a much easier goal to reach with a deal than in the House.

Of course, come January, both the Senate and the House become more Democratic, meaning a deal would require less GOP support to pass.  And with Congress headed home for the holiday and not due back until December 27th, the time window to get a deal done before the cliff goes into effect is running short.

I think at this point it is 50/50 that we get a deal before the New Year.  Unfortunately for congress and the President, the Mayan Zombie Invasion (or whatever nonsense was supposed to happen today) didn't happen, so they will have to deal with this issue.

Expect a deal of some sort early in the New Year if we don't get more 11th-hour heroics in the next week and a half.  It might look something like having rates rise on those making over $400 or $500K, having Social Security indexed to chained CPI rather than regular CPI-U, patching the AMT and repealing some of the DoD sequestration cuts.

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Is Anyone Really Surprised by the Disfunction in Washington?

The hand-wringing in the press and in commentaries has been predictably vicious this week - why can't Washington work together?  Why aren't our elected officials reaching compromise?

My question is - is anyone really surprised that we are approaching the edge of the "fiscal cliff" without a solution?

There is nothing in the history of negotiations between House Speaker Boehner and President Obama that indicates a strong capability to come to compromise.  And interestingly, those are probably the two most moderate voices in the room - Boehner's caucus consists of a lot of die-hards who have no interest indealing while Boehner actually wants a deal and many on the left would be happy to let negotiations fail and blame the GOP.

I always knew that if there was going to be a deal - and there still could be - although a "grand bargain" that permanently solves problems around revenue and entitlements seems increasingly unlikely (another interim patch seems more likely) - it would happen in the 11th hour.  Politics these days simply doesn't allow anything different.

Let's face it - the House GOP and the Democrats in the Senate and the White House were elected by different constituencies to do different things.  And they are both representing what they ran on.

So how did we elect people with such divergent agendas?

Well - we did - but not the way you might think.

Democrats got 1% more votes than Republicans in House races this fall.  Democrats won the national congressional vote 49.1% to 48.1%, a smaller, but still decisive margin from President Obama's popular vote total.  In other words - very few people actually split their tickets to get the result we got.

So how did the GOP swing a House majority with 1% less votes than the Democrats?  It all comes down to districts and there are 3 principle causes of the districting advantage for the GOP that leads to a House that is so different from the national vote:
(1) Inherent Demographics
Democrats tend to live in cities.  Republicans tend to live in suburbs, exurbs and the countryside.  This alone wouldn't create a House imbalance.  But it's a question of proportion.  Take Pennsylvania as an example - in the City of Philadelphia, Democrats win about 80% of the vote in a normal election.  In outlying Bucks County, Republicans normally win about 60% of the vote.  If you look at three congressional districts, one in Philadelphia and two in Bucks County, you will get 1 Democrat and 2 Republicans in congress, even though the total vote between the three districts will be roughly 50/50.
(2) Gerrymandering
Every 10 years, the 50 states (or at least the 43 that have more than 1 House seat) redraw district lines.  In a few states this is done by a non-partisan judicial commission.  In most states, however, lines are drawn by the state legislature and the Governor.  In 2011, when lines were being redrawn, Republicans controlled completely 25 state legislatures with 9 that were either split-control or nonpartisan and only 16 controlled by Democrats.  Republicans also controlled redistricting in big prize states like Texas, Florida and Pennsylvania.  When you get to draw the lines, you will draw them in a way that favors your party - mainly by concentrating your opponents in a few districts and spreading out your supporters to win more districts.
(3) The Voting Rights Act
The Voting Rights Act of 1965 did a great many things intended to support the electoral rights of minorities in the United States.  One aspect of the law required the creation of "minority majority" congressional districts - that is, principally districts with high concentrations of black voters intended to promote the election of black congressmen.  While the law did serve that purpose - black representation in Congress increased significantly, it also created inherent gerrymandering, in a way that favored the GOP, since it essentially concentrated black voters in a few districts, creating a few overwhelmingly Democratic districts but many more mildly Republican districts.

Items 1 and 3 have existed for a long time (at least since the 60s), but in the past, other forces gave the Democrats more parity - from the 60s through the 80s there were a large swath of Southern Democrats who largely got wiped out in the Republican takeover of 1994 (and finished off in the past few years.)  Also, the urban-rural and black-white vote polarization has actually increased significantly over the past 20 years.  And Democrats controlled far more state houses in the past 50 years than they did until the Republican gains in 2009 and 2010.

All of this leaves us with a situation where Democrats would have to win the national congressional vote by at least 2% in order to win the majority in the House - not an impossible task in the right year, but a pretty big intrinsic disadvantage.

All of this leads us to the balance of power that we have today - and our present confused, divided nation.

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An Emboldened President Obama Lobs a Gernade, Is This the Ultimate Long Game?

I recall the tax debate of 2010 quite well.  President Obama had campaigned in 2008 on extending the Bush tax cuts for those making less than $250K per year and not continuing them for everyone else.  The debate took to the Sunday airwaves, but in the end the President blinked.  All of the Bush tax cuts were extended for two years, in addition to a new Social Security tax reduction of 2% for the next two years.  In the end, it was darn close to a complete victory for the GOP on taxes at least - although really very little happened to reign in the structural sources of spending.

We are 29 days from the fiscal cliff this time, so there is still a chance for the President to blink, but he is acting anything but compromising this time around.  His opening volley to the GOP, delivered by Treasury Secretary Tim Geithner to House Speaker John Boehner, is everything that liberals would want and conservatives would hate.  It includes:
* Allowing the Bush tax cuts for those making over $250K to expire
* Further reducing tax deductions on the wealthy to raise additional revenue
* Reducing Medicare benefits to upper income taxpayers
* Reducing farm subsidies
* Claiming credit for cuts that are naturally happening in Defense from the wind down of the wars in Iraq and Afghanistan

The GOP predictably hated the proposal.  It is basically a non-starter in the conservative GOP House.  I suspect it was quite obvious to the President that this would be the case.  I'm not sure he cares.

The President's basic negotiating mistake in almost every key piece of policy in his first term was negotiating from weakness.  The President has been giving away the farm before the conversation started and then negotiating from the compromise.  And often, there has not been a GOP counter-proposal, so the President has wound up negotiating with himself, putting forward increasingly conservative policy proposals until the GOP decides to accept one.

What the President is doing is daring the GOP to make a counter-proposal.  He's put forward the most popular tax increases - solid majorities favor raising taxes on the wealthy and put forward fairly vague promises of spending cuts against programs which are not particularly popular.

He is basically saying - "your move, John Boehner".

On the one hand, the President appears to hold all the cards this time:
* The Bush tax cuts WILL expire for everyone with no action, as will all the sequester spending cuts and the GOP is powerless to stop it without agreement from the Democrats
* Obamacare taxes and health insurance exchanges WILL take place under current law
* The President doesn't have to face re-election again - the House GOP does - you would think they have the larger incentive to get something done.

The GOP has held on to one card, however, and that is the federal debt ceiling.  It will need to be extended in 2013 and they can again hold it hostage for their goals, in spite of the potential damage to US credit.  But even on this topic, the President could go bold and claim constitutional authority to pay debts that are the result of previously authorized spending, although the constitution is fairly explicit in giving Congres the power to borrow money, not the President.  But it would likely be tied up in court for a while and be very bruising to the GOP's public image.

Did the President play a very long game to construct this situation?  There is a solid argument for it.  The "fiscal cliff" was set-up by three pieces of legislation that the President negotiated:
* The 2009 passage of Obamacare, which set the bulk of the associated taxes to go into effect on Jan 1, 2013
* The 2010 extension of the Bush tax cuts, which set them to expire on Jan 1, 2013, along with the payroll tax reduction
* The 2011 debt ceiling deal, which set the automatic sequestration cuts to go into effect on Jan 1, 2013

I noted all of this when I wrote about my proposal to whack the deficit by doing nothing - and that is certainly still an option available to the President.

Nobody in Washington wants to eat that many peas at once.  But, in negotiations that it appeared to everyone he was losing in 2010 and 2011, the President set up this gun to the head, where he can negotiate back from a policy base where all of the above things happen and, because of the timing he set up, he can do it all without having to worry about another election.

So, what will happen?

Privately, most in the GOP concede that they will have to give some ground on tax rates, although no one is talking about it in public.  A possible compromise would likely look something like this:
* Allow rates to go up some, but set the threshold higher than $250K.  It might look something like a 37 or 38% rate on incomes over $500K or $750K.
* Give some ground on Capital Gains and Dividends, allowing rates to rise, but not to the full level of ordinary income - perhaps increasing rates on both from 15% to 20%.
* Increase premiums in Medicare on higher income seniors
* Some reductions to domestic discretionary spending and defense spending, but less than would be automatically implemented in sequestration
* Some type of bi-partisan commission to study more fundamental tax reform.

The GOP realizes they have to give some ground to the President and that his hand is strong this time around.  But they probably won't give away the whole farm.

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What Real Tax and Spending Solutions Would Look Like, How Liberal Or Conservative Were Our Presidents?, Giving Thanks

The Real Reform We Won't Get
As fiscal cliff negotiations continue, it has become obvious to me that the field on which the game is being played is a small one.  We are arguing over a 3.6% difference in top marginal tax rates (between 36% and 39.6% for those making over $250K) and over "draconian" spending cuts which amount to $120 billion per year, split evenly across defense and domestic spending.

While it is good that we are having a serious conversation about how to reduce the deficit, it strikes me that the plans are not nearly bold enough.

Republicans are right to call for more fundamental tax reform - our labyrinth of deductions (home mortgage, child tax credits, earned income tax credits, charity, energy efficiency, state and local taxes, passive activity investing depreciation and on and on), exemptions and special rates for differing kinds of income (e.g. carried interest, which is essentially the salary of hedge fund managers as well as dividends and capital gains) produce a system where, on paper, the rates appear to be a smooth escalation from 10% at the low end to 36% at the high end, but in practice, 47% of Americans pay no income tax and Mitt Romney pays but 14% or so (not a criticism of Romney or the 47%, a criticism of our tax code.)

Our other taxes are a patchwork as well - Social Security taxes are actually regressive, hitting the first $110K of income only - so someone who makes $50K pays twice the rate that someone that makes $220K and 10 times the rate of someone who makes $1.1 million.

Corporate taxes are similarly a mess - high marginal rates (35%) but huge companies which can declare profitability to shareholders using one set of accounting methods, can take advantage of the patchwork of accelerated depreciation, favorable inventory accounting and a maze of credits to not be profitable on paper and pay no taxes (see General Electric for an example.)

Both parties are squarely to blame for this mess.  Carve outs, exemptions and deductions are among the most popular ways to give back to your constituents and everybody from Ronald Reagan to Bill Clinton to George W. Bush has expanded that patchwork in some form or fashion.

Fundamental tax reform would start with a few basic principles:
(1) The tax rates that you pay should be simple, transparent and consistent
(2) We should not attempt to tax people into poverty, but everyone else should pay a share of the tax burden that they can reasonably afford
(3) Taxes should be about generating revenue, not about encouraging or discouraging behavior

Simpson-Bowles provided the framework, which both Mitt Romney this Presidential cycle and now House Republicans have embraced - "broaden the base" by lowering deductions and exemptions and therefore be able to lower marginal rates and still increase revenues.  The issue with what the GOP is proposing is that they don't seek to do away with the deductions that really cost money - such as home mortgage interest and charity.  And they don't want to address the disparity in rates charged between "regular" (i.e. earned) income and capital gains and dividends.

On taxes, here is my simple proposal:
* Every individuals tax treatment is the same - this will avoid marriage bonuses, marriage penalties, etc.  Right now, if you are a working class family with one income, marriage is a huge tax boon.  If you are upper-middle class and have both spouses working, it's a huge penalty.  Let everyone pay taxes on their income.
* Treat all income equally - whether it is capital gains, carried interest, earned income, dividends, bond interest, whatever.  Add up everything you made last year.
* Exempt the first $35,000 per year in income and index that amount for inflation.  That is approximately the poverty level income for a family of four - a generous exemption that would ensure that no one is taxed into poverty.
* Apply a simple 20% tax rate to all income above the $35,000 level, regardless of source.

You could do your taxes on a post-card.  No more complex forms to fill out.


The revenue effect would be as follows.  There are approximately 155 million people in the workforce and assuming that most of them meet the $35,000 threshold, there would be about $5.4 trillion in income exempted from taxation.  But there is about $13.4 trillion in total income available, leaving $8 trillion subject to the 20% tax or, in other words, generated revenue of $1.6 trillion.
That's a big increase from the $1.2 trillion that is currently collected each year in income taxes.

But wouldn't this system be less progressive?

Actually no.  The $35,000 exemption provides a high degree of progressiveness while avoiding the trap of loopholes for higher incomes.

The effective tax rates paid at various income levels would be as follows:
At $35,000 you would pay an effective tax rate of 0%
At $50,000 you would pay an effective tax rate of 6%
At $75,000 you would pay an effective tax rate of 10.7%
At $100,000 you would pay an effective tax rate of 13%
At $200,000 you would pay an effective tax rate of 16.5%
At $500,000 you would pay an effective tax rate of 18.6%
At $1 million you would pay an effective tax rate of 19.3%
At $10 million you would pay an effective tax rate of 19.9%

So it is actually a very progressive and simple system that generates a ton of income.

So who pays more?
(1) People who currently take big advantage of deductions - generally upper-middle class people who have large homes and therefore large mortgages and live in high tax states.  I think we'd all agree these folks can pay a little more.
(2) High income earners who have a high percentage of their income in the form of dividends and capital gains versus ordinary income.  I think most would agree that the Mitt Romneys of the world can afford to pay 19.9% instead of 14%, right?
(3) Middle-class homes with lots of kids.  Right now, if you make $50,000 and have lots of kids, there is a good chance that you don't pay any income taxes.  Under this plan, you'd owe $3,000 per year.  This is probably the toughest sell in this plan, but don't we want everyone who can afford it to contribute a little?

By adopting this fair, simple, plan, we cut the deficit by $400 billion per year, about the same amount as if we simply let the current tax rates revert as will happen if nothing is passed, but this is a far more fair system that encourages economic activity by having a low marginal rate and eliminates a lot of the inherent unfairness in our system.

On the spending front, we'll deal with 3 basic categories - defense, entitlements and everything else:
On defense, we currently spend about $716 billion per year.  This includes about $298 billion spent on personnel, supplies and military housing with the balance being spent on equipment, R&D and construction.

I would not touch the money spent on personnel - we need troops and we have an obligation to pay them a reasonable rate and feed and clothe them.  But there is over $400 billion spent on equipment that could be cut dramatically.

Adjusting for inflation, spending on personnel, supplies and housing has risen by 25% since 1993.  All other military spending (equipment and R&D) has risen a whopping 84%.  Returning this spend to inflation-adjusted 1993 levels by cancelling programs such as new fighter jets we don't need (it's been over 60 years since a fighter jet was used in combat), nuclear subs (which have never been used in combat) and the like would yield a savings of $190 billion per year.

On entitlements, there are no quick fixes, as we have current obligations to current retirees that no one wants to touch.  Presently, we spend about $1.6 trillion per year on Medicare and Social Security and take in about $900 billion per year in the taxes that fund them.  This is a little deceptive in that this year includes the 2% payroll "tax holiday" that takes about 15% of the tax revenue away from the system, but we clearly still have a problem and it is getting worse with rising health care costs and increased life expectancy.

My proposals are fairly straightforward:
(1) Allow the tax holiday to end as planned
(2) Raise the Medicare retirement age from 65 to 67 for those presently 50 and under
(3) Adjust the Social Security increase from the CPI-U to the Chained CPI-U
This essentially adjusts the cost-of-living increases for social security to more accurately reflect the underlying economics - CPI-U assumes that people keep buying the same things regardless of their cost, Chained CPI-U assumes people modify their buying behavior to prices - for instance, people might buy chicken instead of pork if pork prices rise more than chicken.  The effect of this would be a gradual slowing of the increasing rate of payout in social security payments.
(4) Cap Medicare expenditures at current rates per person, adjusted for inflation
This cap would have the effect of requiring trade-off decisions if medical inflation continues to outpace general inflation.  Yes, this is a form of rationing - it would likely mean that you couldn't get every available treatment at will.  But there is no way to give everyone every treatment at will and contain costs.  It would put pressure on the system to get more efficient.
(5) Eliminate the payroll tax cap on Social Security
Tax all income, not just the first $110K.  Someone making $250K can afford to pay the same rate as someone making $110K.

These changes would not have a dramatic immediate effect on the deficit, since most manage the future rate of increase of spending, not cut current spending.  These actions would reduce the current deficit by about $365B, but would reduce future deficits but far more than that over time and make the system more solvent.

On all other spending,
The choices are tough.  I definitely do not want to cut funding for infrastructure spending, which is one of the highest dollar returns that a government can invest in and is sorely needed.  And I certainly don't want to cut things like the Veterans Administration - our budget situation can't let us not fulfill our obligation to our veterans.  I'd propose the following:
(1) Eliminate Farm Stabilization (a.k.a. farm subsidies)
I've never understood why we subsidize large factory farms out of the federal budget.  The broad availability of crop insurance and the large capital that companies like Monsanto and ADM have at their disposal make this utterly unnecessary.  Eliminate it entirely and you save $13B.
(2) End Extended Unemployment Benefits
Under normal circumstances, you can collect unemployment for 6 months.  Under current law, we have extended it to almost 2 years.  This makes sense at the front-end of an economic shock.  But at this point, if you haven't found work in your field, it's time to accept work in another field.  Reverting to normal unemployment payouts would save approximately $40B per year.
(3) Reform Federal Pensions
Federal pensions are among the most generous out there - far more generous than in private industry - and are costing $127 billion per year and growing.  Make a 401K contribution match, similar to private industry, but end the practice of guaranteed lifetime income for federal workers - no one in the private world gets such benefits anymore.  Assuming that you could cut 25% of the cost (a very conservative assumption), you would save $32B per year.
(4) Manage FDIC Rates
We have the unusual situation right now where the FDIC is running a deficit because of the large number of bank failures - historically it has turned a profit - the FDIC should adjust it's insurance rates to make up for the increased risk it has experienced, as any insurance company would do.  This would save $28B per year from the current deficit.

All told, I'd cut $113B out of discretionary spending without touching, infrastructure, VA benefits, food stamps or education.

So if you add up all these numbers:
$400 billion from tax reform + $365 billion from entitlement reform + $113 billion from discretionary spending reductions = $878 billion in deficit reduction.

Against a $1.1 trillion deficit, that's a pretty awesome year one down payment.  And if we also capped other programs at the rate of inflation, you could take care of the rest as the economy naturally grows (eventually!) and costs on other programs come down as more people find work.

Of course, all of this won't happen, but I wanted to dream for a moment about what would be possible if we didn't view the world so myopically.

Liberals vs. Conservatives
What defines a liberal versus a conservative?

In social terms, it is complex, but in economic terms, I think there is relative consensus - a conservative wants smaller government and lower taxes and a liberal wants larger government and therefore higher taxes.


The conventional wisdom is that Republicans generally pursue more conservative policies, Democrats more liberal policies.  Reality, as always, is a little more complex than that.

I've looked at US Presidents since World War 2 and analyzed what happened during their administrations on taxes and spending.  I've looked at the net CHANGE in taxes and spending as a percentage of GDP during their administrations versus the absolute levels since every President has to deal with a baseline budget coming in.

The obvious limitation of this methodology is the composition of Congress.  For instance, a liberal President might want to spend more, but a hostile congress could have blocked the spending or vice-versa with a conservative congress.  So, we'll discuss that impact with the numbers.

Looking at the four quadrants that are possible, I've assigned the four descriptions:
(1) Deficit Hawks
These Presidents have the attribute of HIGHER taxes and LOWER spending.  In other words, they shrunk government but also paid the bills.
(2) Deficit Spenders
These Presidents have the attribute of LOWER taxes but HIGHER spending.  They effectively grew the size of government, but didn't pay for it.
(3) Liberals
These Presidents pursued a larger government policy - higher taxes and spending.
(4) Conservatives
These Presidents pursed a smaller government policy - lower taxes and spending.

Deficit Hawks: Clinton, Obama
Deficit Spenders: W. Bush, H.W. Bush, Ford
Liberals: Carter, Johnson, Kennedy
Conservatives: Reagan, Nixon, Eisenhower

The chart is actually quite stunning in showing how much of an outlier the W. Bush administration was.  Government spending increased by 7% of GDP from 2001 to 2009 going from 18.2% of GDP to 25.2% of GDP.  Meanwhile, taxes fell from 19.5% of GDP to 15.1% of GDP.  The net result is that in that 8 years, a budget surplus of 1.3% of GDP turned into a massive deficit of 10.1% of GDP.

So how did this happen?
The spending increase basically comprised three things - the spending on the wars associated with Iraq and Afghanistan and the creation of the Department of Homeland Security, a large increase in Medicare spending associated with the prescription drug program and massive spending at the end of his term dealing with the financial crisis - including TARP and higher cost for programs like Food Stamps and Unemployment as the economy tanked.

The tax receipt reduction was principally the byproduct of the 2003 tax cuts that Bush pushed through that slashed rates across the board.

So how influential was congress in this mess?
From 2001-2003, Republicans controlled congress.  From 2003-2007, Republicans controlled the House and Democrats the Senate.  From 2007-2009 Democrats controlled both chambers.

So, breaking it down by era, we can look at the changes that happened during each stage:
From 2001 to 2003 - taxes fell 3.2% of GDP and spending increased 1.5% of GDP
From 2003 to 2007 - taxes increased 2.5% of GDP and spending was flat
From 2007 to 2009 - taxes fell 3.4% of GDP and spending increased 5.5% of GDP

The big hits to taxes came at first with the Bush tax cuts and then with his early attempts at tax stimulus in 2007 as the economy headed south (along with the decrease in taxation caused by reduced profits at large corporations.)

The biggest spending hit was clearly TARP and the fallout from the recession, but the prescription drug program and expansions in discretionary spending which happened under an all GOP watch also contributed.

So, in the case of Bush, the blame is somewhat shared and the numbers are exaggerated by an economic crisis, but we were clearly on an irresponsible path far before then.

The biggest deficit Hawk on our list is Bill Clinton.  Clinton faced a Democratic congress from 1993-1995 and a Republican Congress from 1995-2001.

1993-1995 saw a 0.8% of GDP reduction in spending and a 0.9% of GDP increase in taxes
1995-2001 saw a 2.4% of GDP reduction in spending and a 1.1% of GDP increase in taxes

Interestingly, the 6 years of GOP-control looked a lot like the 2 years of Democratic control in terms of trend.  The Democratic congress set tax hikes in motion and reduced military spending - the GOP congress reined in domestic discretionary spending.  So there is some shared credit, but also a clear trend with Clinton.

The other President whose numbers may appear surprising is Obama.  The conventional wisdom is that deficits have exploded under Obama thanks to prolific stimulus spending.  In fact, spending has fallen modestly and tax receipts are up modestly.  This is partly deceptive, since Obama's "base" includes emergency TARP spending that has lapsed.  But it also speaks to the mess that Obama inherited in the budget, with 10%+ deficits in the baseline.

What parties say and what Presidents do often diverge.  Leadership is about more than party membership.

Giving Thanks
Today is Thanksgiving and as I have traditionally done, I wanted to give thanks for some things that are great about our nation.
* Thank you to the soldiers who go to far-flung dangerous lands to guard our freedom.  And thanks to Congress and the President for giving brave gay soldiers equal standing.
* Thank you to the voters of Oregon and Colorado for forcing politicians of both parties who don't want to talk about the failed "War on Drugs" to deal with the issue.
* Thank you to the poll workers who worked long hours to protect the most sacred rite of our republic - the integrity of the vote.  Here's to hoping politicians finally make common, secure voting technology a priority in the coming year.
* Thank you to FEMA and all of the volunteers and emergency workers that made an awful storm on the east coast a little less awful.
* Thank you to everyone who ran for public office this past election - win or lose - for putting themselves out there and giving us choices
* Thank you to everyone who works Thanksgiving day so that we can enjoy it with our families - cops, fire fighters, grocery store workers - thank you to all of them.

I hope that you are enjoying turkey and football with your family today - or whatever your personal Thanksgiving tradition is.  And if you are working today, thank you again, and I hope that you get some time with your family.

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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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