WASHINGTON -- Five people will gather Friday inside the White House to
begin making decisions that could affect the pocketbooks of 315 million
When President Obama sits down with the Republican and
Democratic leaders of Congress, only 46 days will remain before the
nation risks plunging over the "fiscal cliff" - a pileup of scheduled
tax increases and spending cuts that threaten to drain $560 billion out
of the economy next year and derail the recovery.
will be high-stakes poker, holding the promise of great rewards for an
economic rebound if Washington succeeds and the peril of another
recession if it fails.
Promise or peril, some Americans are going
to feel the pinch. Should Obama get his way, those with annual incomes
above $250,000 will face higher tax bills. If Republicans come out on
top, tax rates and defense spending will remain the same, but social
programs will face budget cuts.
A compromise portends discomfort,
most likely in the form of reduced paychecks, jobless benefits and
business tax breaks. And a stalemate means higher taxes and reduced
federal spending across the board, including at the Pentagon.
last scenario has Main Street and Wall Street worried. "We think the
fiscal cliff would trigger an avoidable and unnecessary recession," says
David Riley, head of Fitch Rating's sovereign-debt rating committee,
comparing a decision to go over the cliff to a "kamikaze"
deficit-cutting mission. "It would impose real costs on real people."
a sensible solution to avoid the fiscal cliff and put the nation's
finances on a more sustainable path offers lawmakers the chance to latch
on to a budding economic recovery. An improving housing market and a
blossoming oil and gas market already have economists projecting that
the U.S. could add 12 million jobs over four years if policymakers don't
mess things up.
"Main Street will come alive. All the lights will
be bright, and the economy of this nation will be the envy of the
world," says Republican Judd Gregg, former Senate Budget Committee
chairman. "We are ready for boom times in the nation if we could just
get our fiscal policy under control."
Now that the election is
over, and the same cast of characters is left watching the store, the
whole world is waiting to see what they do. Businesses fearing another
recession are waiting to hire. Workers are wondering if they'll lose a
2-year-long reduction in the payroll taxes that fund Social Security - a
break worth $20 a week to the median working family. Domestic and
international financial markets are waiting to see if a U.S. recession
would further damage a global economy already weakened by European
austerity and a marked slowdown in China.
Americans are hopeful
but not confident. Two in three of those surveyed in a USA TODAY/Gallup
Poll during the past week want the two sides to split their
differences, 45% want an equal division between tax increases and
spending cuts, 30% want mostly spending cuts and only 10% oppose tax
increases altogether. One in three expect negotiations to fail and the
economy to tumble over the fiscal cliff.
The cliff is already
holding back the recovery, as companies keep capital on the sidelines in
fretful anticipation. David Cote, CEO of Honeywell and a member of the
commission that recommended nearly $4 trillion in tax increases and
spending cuts in 2010, sees it in reduced hiring. Since spring, he has
replaced only 25% of the workers who left Honeywell, a decision that has
cost about 600 jobs so far.
"The last thing you want is to hire a lot of people and then have to
lay them off," Cote says, explaining why the other 75% of people who
leave Honeywell are not being replaced. "Capital is a coward."
cheered by Obama's re-election and small gains for their party in the
Senate and House believe they have the upperhand in negotiations,
particularly on taxing higher-income Americans. Unions and liberal
groups have seized on that advantage with a grass-roots and advertising
campaign calling for higher taxes on the wealthy and no reductions in
benefits for Social Security, Medicare and Medicaid.
changed (election) night," says Mary Kay Henry, president of the Service
Employees International Union, one of several labor leaders to meet
with Obama at the White House Tuesday. "We are going to call upon our
government to respect the will of the voters."
including the two who will meet with Obama on Friday - House Speaker
John Boehner and Senate Minority Leader Mitch McConnell - want to hold
the line on income tax rates and force bigger reductions in benefit
"The president needs to lead," McConnell said Tuesday.
"And that means offering a concrete plan that takes into account the
fact that half the Congress opposes tax hikes - not because we're
selfish or stubborn, but because we know it's the wrong thing to do,
because we know it will hurt the economy."
In the middle are
fiscal watchdogs, business executives and young Millennials who want a
deal, even if it includes tough tax hikes and spending cuts needed to
trim annual $1 trillion deficits and control a $16.2 trillion debt. A
dozen CEOs get their White House session with Obama today.
think the fiscal cliff is the best opportunity Congress has had in
decades to solve some of the major economic and fiscal problems this
country faces," says Jim Kessler, senior vice president for policy at
Third Way, a moderate Democratic think tank. "This is a now-or-never
moment that we should embrace."
A hard landing
As Obama demands higher tax rates for the wealthiest and Republicans
insist that won't happen, the two sides could go briefly past Jan. 1
without a deal on most of the expiring tax breaks. That could lead to an
economic slowdown and joblessness heading toward 10%. T. Rowe Price
chief economist Alan Levenson says Obama can reduce the impact for a
short time by ordering the Internal Revenue Service to collect 2013
withholding taxes at 2012 rates.
If Washington fails and all of
the fiscal cliff's tax and spending measures stay in effect, the economy
would fall into a mild recession in the first half of the year before
resuming its weak growth rate in the second, the Congressional Budget
Office estimated last week.
Unemployment, now 7.9%, would rise to 9.1% by the end of 2013, it said.
unlikely that the downturn, while expected to be short, would be as
nasty as the 2008 financial crisis. Financial markets think CBO's
forecast is too optimistic, because the economy is only growing a little
faster than 2% this year and the cuts could subtract up to 3.6% or more
of total economic activity. The International Monetary Fund says
"global spillovers would be amplified through negative confidence
effects, including, for example, a global drop in stock prices."
one of the bond-rating services whose threats to cut the U.S. bond
rating is driving pressure to make a deal, says unemployment could top
10%. Both Fitch and Moody's Investors Service say failure to reach even a
temporary deal likely would result in a downgrade. The National
Association of Manufacturers says going over the cliff could forfeit 6
million jobs and a 10% loss in household income.
"It could be a lot worse than people expect," Cote says.
non-partisan Tax Policy Center estimates that toppling over the cliff
would cost about $3,500 per U.S. household. A typical middle-income
family would see taxes rise by about $2,000. Those in the top 1% would
pay an additional $120,000, while the average low-income household would
pay about $400 more.
Another potential downside for taxpayers:
Congress has to decide whether to let the payroll tax cut and extended
jobless benefits expire, since both were tied to the recession.
Eliminating the payroll tax cut and unemployment benefits could cost the
economy 800,000 jobs, CBO says. The Wall Street firm BlackRock
estimates it would cut the economy's 2% growth rate in half.
extended unemployment insurance expires on schedule, 2.1 million
Americans would see benefits stop immediately at the end of the year - a
"human cliff," says Rep. Sander Levin, D-Mich., top Democrat on the
House Ways and Means Committee.
And if lawmakers don't agree to
prevent the alternative minimum tax (AMT) from hitting millions of
upper-middle-income taxpayers, the IRS might have to delay processing
tens of millions of returns in January and February.
spending cuts would trim about $55 billion, or nearly 10%, from the
defense budget next year. While Obama has exempted the armed forces from
personnel or pay cuts, more than 100,000 civilian employees could lose
their jobs next spring. The defense industry would be forced to
downsize, reducing employment among defense contractors gradually,
according to the Center for Strategic and Budgetary Assessment. There
would be no base closures.
The cuts would cause an equally large
reduction in domestic programs, ranging from air-traffic control to
agriculture. That could threaten nearly 25,000 Homeland Security jobs,
45,000 cancer screenings for women and 100,000 Head Start placements,
according to House Appropriations Committee Democrats. Medicare would be
cut by 2%.
A soft landing
This most likely scenario includes extending most if not all of the
Bush tax cuts and making a down payment on spending cuts. The payroll
tax cut and extended jobless benefits could expire; the AMT could be
patched. A timetable for actions on spending and income taxes would be
Leading up to Friday's initial White House meeting, the
public appears to be siding with Obama on taxes. Surveys of voters taken
on Election Day showed 47% of Americans favor raising individual income
taxes on the wealthiest, while 35% want to keep taxes where they are.
and other Republicans insist that Obama's proposal to push the top
income tax rate back up from 35% to 39.6%, where it was under President
Clinton, would hurt small-business "job creators" who pay personal tax
rates rather than corporate rates. Boehner says it would cost 700,000
About three-fourths of U.S. manufacturers, mostly small
ones, use personal rates, according to the National Association of
Manufacturers. Their average taxable income: $384,000. Under Obama's
proposal, a sole proprietor matching their profile would pay about
$6,750 more per year.
Restoring payroll taxes to their 2010 level
would raise about $115 billion, and ending the extended unemployment
insurance benefits would save another $40 billion. Along with spending
cuts chosen by negotiators rather than leveled across the board, an
interim deal could produce "a down payment of $300 billion to $500
billion to show that we're serious," Cote says.
has patched the AMT every year since 1969, it's likely to do so again.
Today, the AMT, originally intended to ensure the wealthy pay a minimum
income tax, usually hits taxpayers who have a household income over
$75,000 and are married with more than two kids, according to Bob
Meighan, vice president at TurboTax. It would hit an estimated 28
million for the first time if Congress doesn't act, raising their 2012
tax bills by an average of $3,700.
A compromise deal would reduce
growth next year by as much as 1.5 percentage points, says Mark Zandi,
chief economist at Moody's Analytics, but would hurt average taxpayers
less than many people believe. The recovering economy is nearly ready to
pick up that slack, partly because of the improving housing market,
rising consumer confidence and the effect that more certainty may have
on business investment, he says. Fast-expanding domestic oil and gas
supplies are another tailwind that will help the economy, BlackRock vice
chair Barbara Novick says.
"It's time," Zandi says. "Our economy is strong enough to digest the fiscal drag. If we lay out a path, the economy will jump."
A safe landing
The least likely scenario is the opposite of going over the cliff:
striking a "grand bargain" during the lame-duck Congress and outlining
how to get $3 trillion or more in deficit reduction over the next
Fiscal watchdog groups have joined forces with corporate
CEOs to encourage such a deal. The "Fix the Debt" campaign has raised
more than $36 million, signed up more than 100 business leaders and
built bipartisan support for a balanced deal. More than 300,000
Americans have signed its petitions.
But there are dangers to
agreeing on too much, too soon. It could trigger a European-style
recession, which could turn policymakers back toward stimulus spending
and tax cuts, such as those enacted in 2009.
One key to a
long-term deal: eliminating or at least reducing tax deductions and
loopholes that cost the government billions. Targets include tax breaks
for oil and gas companies, and the wealthy, but some could affect
middle-income taxpayers, such as breaks for home mortgage interest and
employer-paid health insurance.
"One of the prices to get tax reform is that people are going to have to pay more," Cote says.
other major part of any grand bargain would be changes to entitlement
programs, led by Medicare and Medicaid. Social Security is more likely
to be handled separately.
Republicans are looking for an eventual
increase in Medicare's retirement age from 65 to 67 and some form of
means-testing to collect more from higher-income seniors. Obama last
year entertained changes in the Medicare retirement age during talks
with Boehner over raising the debt ceiling. Those talks failed, but they
form the basis of a new deal.
In an interview with USA TODAY,
Boehner puts the problem in historical terms: "The next two years," he
says, "are going to be some of the most consequential we've had in 50 or