12/4/12 – The Other Side Shows Up to the Game

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Dec 4, 2012 10:22:04 AM

and tagged Fiscal Cliff, Politics and the Economy

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Apparently, Obama’s demand that the Republicans come up with a plan had some effect—they did. Not surprisingly, the offer includes much less new revenue than the White House proposal and much larger spending cuts. The New York Times has a pretty good graphic today on page A16 that compares the initial offers.

A few interesting points:

First, Boehner explicitly tied the offer to the Simpson-Bowles plan created by the Obama-appointed commission, making it something the President will have trouble dismissing out of hand.

Second, the GOP essentially conceded on points it previously fought during the debt ceiling negotiations, showing just how far the ground has shifted.

Third, this offer—including the revenue increases—was explicitly endorsed by the whole Republican House leadership, including Paul Ryan. Unlike during the debt ceiling negotiations, when Boehner couldn’t be sure he had his troops in line, this time everyone has signed on.

If we take the two offers as a starting point and assume that the final deal, if there is one, will fall somewhere in the middle, then any outcome will be substantially more focused on tax increases—or, excuse me, revenue increases—than spending cuts. Economically, this will be more counterproductive, as the negative effect of tax increases on economic growth is far greater than that of spending cuts. Nonetheless, this appears to be what will result if a deal is reached.

The question remains, will a deal be reached? The Republicans, as noted above, have already come a long way and seem to have their own house in order. What’s driving them are polls that suggest the Republicans will be blamed if a deal isn’t reached, as described in a Washington Post blog post.

As we saw with their initial offer, the Democrats are becoming less flexible even as the Republicans are becoming more so, and for similar reasons. The fiscal cliff would result in higher tax revenues, especially on the rich, and reduced military spending, both of which are Democrat goals. It would go a long way toward solving the deficit problem. And the other guy would get blamed. The Democrats do have incentives to keep negotiating, but there’s no gun to their heads.

The other factor that must be considered is those on both sides who are willing, even eager, to go over the edge rather than compromise. The Wall Street Journal has a good article on page A6, “Negotiators, Cliff Divers Are Racing Each Other,” which points out that the longer the negotiations go on, the more entrenched the positions of the extremes on both sides become, making it even more difficult to actually cut a deal. Add in the time constraints here, and the chances of no deal become even greater.

Having an offer from both sides represents real progress, and the Republican proposal, although vague, is credible and has the backing of the leadership team. This may signal a real chance to start meaningful negotiations, rather than the Kabuki play we’ve witnessed so far.

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