The half-baked fiscal deal and the tough choices ahead

With a fiscal deal that raises income tax rates for the first time in twenty years, albeit only on the top 1% of Americans, President Barack Obama and the Democrats in Congress toasted the arrival of the New Year and a once-in-a-blue-moon victory over Republican opposition to any and all tax increases. But the deal, reached by the two parties after much wrangling and a day past a self-imposed end-of-the-year deadline, is far from the comprehensive “grand bargain” that the President and some members of Congress still hoped to achieve only a few weeks ago. In fact, many of the issues that have been dominating America’s rancorous debate on the debt in the last two years remain on the table and will once again trigger a flurry of negotiations and renewed calls for averting a new fiscal Armageddon in just another couple of months.

Among the sticking points that this recent deal did not address are the so-called “sequester” – automatic across-the-board cuts to defense and other government spending (entitlement programs such as Medicare and Social Security are mostly exempt) that were scheduled to take place at the start of 2013 unless a debt-reduction plan was agreed on and which have only been postponed to the beginning of March – and the reauthorization of the debt ceiling, which, come late February, will need to be raised once again. The deal also does little to tackle the structural drivers of the debt, which is large and growing and which both parties agree needs to be put back on a sustainable path, although Democrats and Republicans are deeply divided on how quickly and in which ways this should be done.

“The only thing this deal does on the deficit reduction side is it raises taxes on the top 1% of Americans by raising their rates,” says Marc Goldwein, Senior Policy Director of the Committee for a Responsible Federal Budget. “Whether that is the right policy or not, politically it is an easy place to be to say that you are protecting 99% of all taxpayers, so what I’m really worried about is that we have already done almost all of the easy stuff and what’s left are the really hard choices.”

Both parties will return to the negotiating table with trump cards of their own. Sequestration worries the GOP more than it does the Democrats because those cuts are particularly damaging to the Pentagon budget, which is sacrosanct for the American right. On the other hand, the White House needs the Republican-majority House of Representatives to vote timely in favor of raising the debt ceiling, lest the US go into default (the drawn-out debt ceiling battle of the summer of 2011 led to the downgrading of this country’s credit rating by Standard and Poor’s.)

Both sides having reasons to go for a compromise should be cause for optimism. But having taken the threat of a tax increase for all Americans off the table with the fiscal cliff deal, the Democrats have probably lost some of their leverage. As a result, they will have a harder time getting more revenue from the next round of talks and they might end up being dragged further than they would like in the uncomfortable territory of entitlement reform.

This is clearly what conservatives are banking on. “We must make very substantial progress on restraining government spending and reforming the entitlement programs so they are effective, affordable, and sustainable,” says J.D. Foster, Senior Fellow in the Economics of Fiscal Policy at the conservative Heritage Foundation in Washington, D.C. “What we most need to see is for President Obama to break with his past traditions and truly lead by proposing real policy changes in these areas.”

The kind of concessions the GOP will be able to extract from the Democrats on welfare spending depends on how far Republicans will want to run with it. “The President has put entitlement reform on the table but I think what Republicans want is more structural reform than where the President is,” says Goldwein. However, Goldwein believes, there already are a few changes to the health and pension programs that both parties could rally behind, including means-testing Medicare benefits (adjusting them to an individual’s income) and moving to the chained-CPI (a more accurate, but less generous, measure of inflation than the one currently in use) for Social Security.

At the same time, Democrats will keep pushing for more revenue no matter how difficult it might be. This could come in the form of a simple cap on existing deductions or of a full-blown rewriting of the tax code. Michael Linden and Michael Ettlinger of the liberal-leaning Center for American Progress recently wrote that “the fiscal cliff deal was a good start, and more than $600 billion in new revenue is nothing to sneeze at but […] more will have to be done to ensure that we have adequate revenues to pay for the public protections, investments, services, and benefits that the American people demand and deserve from their government.”

Because of the combined threat of the sequester and of the debt ceiling, the feeling in Washington is that a deal will be reached once again, this time more explicitly focused on debt-reduction. But with extremely delicate parts of the government on the chopping board, from defense spending to the social safety net, and with the composition of the new Congress practically unchanged from the last one – therefore deeply divided along partisan lines – the fight is sure to be an ugly one.