Pete Davis: 60% Chance We Go Over The Fiscal Cliff
CG&G alum Pete Davis put out the note below on the fiscal cliff to his clients last Tuesday and graciously allowed me to reprint it in full. Pete and I agree completely that there's a 60 percent chance that we're going over the cliff.
Fiscal Cliff: It's way too early to count on a deal. Sure senior staff are talking. Paul Ryan's staff met at the White House yesterday. They're trying to set the broad outlines of a compromise -- dollar amounts of revenue increases and spending cuts. They're working up options. It's going to be another week before President Obama and congressional leaders meet for their first substantive talks. In my experience, the first thing that happens in such a meeting, after opening statements and procedural matters, is they reject all of the options the staff prepared. Then they start arguing among themselves. After an hour or two, they tire of that and walk out on camera and tell the world they made progress. The staff goes back and works all night on new options, and they meet again, and again, and again.
This won't get resolved easily. Here's my short list of impediments:
1. President Obama insists on a tax rate increase on those earning $250,000 or more, and House Republicans balk;
2. President Obama and Democrats refuse to accept revenue increases that won't be scored by CBO, i.e. that depend upon tax reform and/or upon an assumed increase in economic growth;
3. President Obama insists on a Making Work Pay tax credit to replace the lost 2% payroll tax cut for working Americans that Republicans won't accept;
4. House Republicans insist on entitlement cuts that Senate Democrats won't accept. Certainly, Senate Democrats see Social Security as completely off the table, and Medicare cuts will be difficult to achieve because most of the easier cuts were used to pay for ObamaCare;
5. Everyone wants to repeal the $109 b. sequester, but Republicans may object if it's not "paid for;"
6. Democrats want bigger defense cuts than Republicans will accept;
7. Discretionary spending can be shaved a bit more, but not much more without incurring Democratic opposition; and
8. Republicans may refuse to accept a debt limit increase that is not "paid for." A one-year hike would cost about $1.2 tr. There's no way they could pay for that.
I'm not ruling out a deal before Christmas, particularly one which combines a very modest "downpayment" with procedures to deliver tax and entitlement reform. I've always said I see about a 40% chance of such a deal by Christmas. The problem for the market will be to guage how much deficit reduction will ultimately be delivered. I expect to be underwhelmed.
This all comes down to how insistent President Obama will be on raising taxes on the rich and whether he will accept a deal without a rate increase. All of the President's statements so far have upped the ante on a tax rate increase on those earning $250,000 or more. Sure he has caved many times before on a wide range of issues, but will he do so following an election victory and when he never has to run again?
One big final impediment will remain after a deal is announced -- The House may not pass it. In July, 2011, House Speaker John Boehner (R-OH) thought he had agreed to a deal with President Obama which his colleagues would support, but House Republicans rejected it. He was put in the embarrassing position of having to return to the bargaining table to cut a smaller, kick the can down the road deal, with the Super Committee that failed, and the $109 b. sequester that no one wants. I'm sure he'll be a lot more careful this time around to whip his support before finally signing off on a deal. Anything the House Republican Caucus will pass is unlikely to attract more than a handful of Democratic votes, even if President Obama supports it. Boehner will not get united House Republican support for any deal. He may need Democratic votes to pass it, and Nancy Pelosi (D-CA) is unlikely to supply them. That's the problem.
I still see a 60% chance that we temporarily go over the fiscal cliff. The damage is already being done to the economy right now by frozen investment and tax avoiding business sales and dividend payments. After President Obama and congressional leaders exhaust themselves failing to agree and decide to risk the fiscal cliff for a short time rather than accept a bad deal, we will see the underlying power of the political divisions in the United States.