Fiscal Fiasco

I met with our accounts in London this past week. The number one concern among investors here is the US fiscal cliff at the beginning of next year. That seems to be a bigger worry than a breakup of the euro zone. There is a great deal of interest in the upcoming US presidential elections, and a sense that the fiscal cliff is more likely to be averted if Mitt Romney wins. If Barack Obama wins, the fear is that political gridlock will thwart any attempts at a bipartisan compromise on fiscal policy.

I tend to agree with this assessment. However, in either case, I expect that right after the November 6 elections, Congress will pass legislation that will delay the fiscal cliff until mid-2013. That doesn’t guarantee that this problem will be resolved by then even if Romney wins. There is already a big debate about Romney’s fiscal plan.

In the 8/28 WSJ, Martin Feldstein wrote an op-ed titled “Romney's Tax Plan Can Raise Revenue.” It’s no surprise that Feldstein is defending the Romney plan since it reflects some of his suggestions, especially capping the amount that an individual taxpayer can benefit from tax loopholes. It’s a great idea. The Simpson-Bowles deficit reduction plan also targets eliminating lots of the loopholes. The problem is that all those high-priced and high-powered lobbyists in Washington will fight tooth-and-nail to keep the loopholes they worked so hard to stick into the tax code for their special-interest clients. Leaving the loopholes alone but limiting their use by individual taxpayers would certainly help to call off the attack dogs.

However, Republican legislators who signed Grover Norquist’s no-new-taxes pledge might baulk at capping loopholes even if one of their own is in the Oval Office. Norquist, who is president of Americans for Tax Reform, recently claimed that his pledge is more popular than ever. The 6/21 WSJ reported: “As evidence, he says, the pledge is growing in popularity among congressional candidates. In all, 449 incumbents and challengers signed the pledge in 2010, including 241 challengers and 208 incumbents. This time around, 534 have signed the pledge, including 255 challengers and 279 incumbents, he said.”

In his op-ed, Feldstein wrote: “Mitt Romney's plan to cut taxes and offset the resulting revenue loss by limiting tax breaks has been attacked as ‘mathematically impossible.’ He would reduce all individual income-tax rates by 20%, eliminate the Alternative Minimum Tax and the estate tax, and limit tax deductions and loopholes that allow high-income taxpayers to reduce their tax payments. All this, say critics, would require a large tax increase on the middle-class to avoid raising the deficit. Careful analysis shows this is not the case.”

The question is whether the no-new-taxes crowd would accept a cap on loopholes in exchange for lower marginal tax rates. I think it is a very fair trade. I am especially fond of the Simpson-Bowles plan, which would eliminate all if not most tax loopholes and use the money to slash marginal tax rates and still put us on a path towards significant deficit reduction. Feldstein’s approach may increase the chances of implementing a lite-version of Simpson-Bowles. That would be better than no plan, which remains a possibility if political gridlock prevails no matter who wins in November.

In his 8/23 NYT column, David Brooks blamed Republican VP-nominee Paul Ryan for scuttling the Simpson-Bowles plan. Ryan was a member of this commission and voted against the plan: “Ryan voted no for intellectually coherent reasons. He argued that the single biggest contributing factor to public debt is the unsustainable growth of Medicare. Yet the Simpson-Bowles plan did nothing to restructure Medicare, and it sidestepped health care issues generally. Ryan said that it was silly to come up with a debt-reduction proposal that didn’t fix the single biggest driver of the nation’s debt.”

Brooks claims that “[i]f Ryan and the other House Republicans had voted for the Simpson-Bowles proposal, it would have gone to Congress for up-or-down votes, regardless of how President Obama reacted. We would have had national action on debt reduction.” That’s a stretch, to say the least. The Democrats weren’t blameless, and the President showed no interest in pushing for the plan whatsoever. Here are the facts:

(1) The original bipartisan legislation proposing the commission would have required Congress to vote on its recommendations as presented, without any amendment.

(2) In January 2010, that bill failed in the Senate by a vote of 53-46, when six Republicans who had co-sponsored it nevertheless voted against it. Thereafter, Obama established the Commission by Executive Order 13531.

(3) The Simpson-Bowles report was released on December 1, 2010, but failed a vote on December 3. Eleven of 18 votes were in favor, with a supermajority of 14 votes needed to formally endorse the blueprint. Among the seven dissenters were four Democrats. A curse on both their Houses!

On the other hand, in his acceptance speech in Tampa, Ryan failed to mention that he was a member of the commission and voted against its proposal. Instead, he noted that President Obama “created a bipartisan debt commission.” He said, “They came back with an urgent report. He thanked them, sent them on their way, and then did exactly nothing. Republicans stepped up with good-faith reforms and solutions equal to the problems. How did the president respond? By doing nothing--nothing except to dodge and demagogue the issue.”

A curse on both their Houses!

Finally, for now, here’s one more item on this subject from last week’s news: On Tuesday, Gene Sperling, the influential head of President Obama's National Economic Council, said that if the President is re-elected he will seek a sweeping deficit reduction agreement with Congress based on the “basic framework” of the Simpson-Bowles commission report. Sperling said he expects aggressive budget talks to begin after the November 6 election to avoid taking the nation over the fiscal cliff. Sperling said Obama would like to negotiate a deficit reduction accord similar to the deal he was discussing with House Speaker John Boehner last year. However, he made it clear that Obama would insist on a deficit reduction deal that includes additional revenues and did not have spending cuts that are as deep as those proposed by congressional Republicans led by House Budget Committee Chairman Paul Ryan.