Less than 50 days until Fiscal Cliff : Who blinks first?

I have recently returned from post-election meetings in Washington, D.C. where universal attention is now focused on the “fiscal cliff”, the automatic tax increases expected to kick in at the beginning of the year due to the expiration of Bush tax cuts and other provisions.  Lawmakers are once again preoccupied with breaking the impasse that has hamstrung policy advancement since the days of the debt ceiling crisis (May through August 2011), rejection of Obama’s bipartisan deficit committee proposal (also know as Simpson Bowles) and subsequent alternative proposals.   Time to resolve a large hit to the economy is of the essence, with less than fifty days until the deadline, and the consequences are sobering.

Last week, The Congressional Budget Office published a report that reiterates the difficult scenarios of either maintaining scheduled tax raises or extending Bush tax cuts:

1)                   If all provisions are allowed to expire, the debt to gdp ratio will come down over ten years but the economy will face a probable recession in 2013 or,

2)                   Extending tax cuts would maintain positive economic growth but increase long-term debt to unsustainable levels.

While it is debatable how much can be achieved by a “lame duck” Congress in 21 days of sessions until the end of the year, here are some of the things that lawmakers and pundits are saying inside the beltway:

• Both parties are claiming a “mandate.”  The Republicans base their assertion on the very close popular tally for the Presidential race.  The Democrats, of course, point to Obama’s electoral victory (and 49.4% of the popular vote versus Romney’s 49.1%.)  It looks to me as though Americans hedged their bets:  voting  progressively on social policies for Obama, but conservatively on spending policies since the Republican Congress controls spending.  The American electorate wants many things – universal healthcare, maintenance of Social Security and Medicare, and does not want to pay for it!

• Some lawmakers claim that going over the fiscal cliff could easily be reversed and that while uncertainty would prevail in the meantime, policy and tax reform cannot be hurried.  This argument could also be used to support a temporary solution and would be analogous to the last three years of continuing resolutions to enact annual budgets.  And while both sides may be using rhetoric, this writer asks, have any of these folks seen the stock market reaction to status quo politics when the stock market sold off almost 3% after the election?  Could lawmakers really be so deaf to financial markets, corporate CEOs, foreign leaders, credit agencies and the IMF?  

• Present lawmakers are likely to take an approach that buys time (until the more cantankerous newly elected Congress arrives in Washington) and avoids the automatic cuts in defense and discretionary spending.  The prevailing assumption is that the real deal will take some time. 

• Some numbers:  The US Treasury collects almost $1.3 trillion in revenues from individuals, while $1.1 trillion is lost to loopholes and deductions.  “Lowering rates and broadening the base” is probably intuitively attractive to any taxpayer because the verbiage seems to promise that those who are already paying will pay less at lower rates.  I expect, however, that all of us will be paying more in the long run despite any attempt by either party to protect a particular constituency.  Potential targets include homebuilders (save the mortgage interest deduction) or charitable organizations (save the deduction for charitable donations).  On the spending side,  entitlements could be tweaked with Social Security cost of living increases adoption of “chained CPI”.[1]

It remains to be seen if things are going to get better, or get worse before they get better, or just get worse.  As of Friday, both Boehner (who does not want to go down in history as a political hack) and Obama (also considering his legacy) have made conciliatory remarks, a dim positive if not yet substantiated by any agreement.  In any event, the Huffman Broadsheet promises to keep you up-to-date on how policy impacts financial markets and the economy and who blinks first.

While the S&P 500, Nasdaq (CCMP or orange line), and Dow Jones (INDU or yellow line) are up nicely for the year, the market accelerated its retreat last week after peaking in September.  Source: