No clear resolution for the US fiscal cliff

When President Barack Obama took office in 2008, there was little time for rest or reflection. The economy was in freefall and immediate action was required.

This time around, the situation is not so dire. But once again, the President faces a pressing post-election economic challenge: the January 1 deadline known as the fiscal cliff.

So, a quick recap on how we got here: during the lame duck session of Congress in late 2010, Democrats and Republicans agreed to extend the Bush tax cuts and and institute a payroll tax holiday, both set to expire at the end of 2012.

Then, last summer, as part of a deal to raise the debt ceiling, Obama agreed to $1 trillion in spending cuts that would begin to be implemented on January 1, 2013. Half of the cuts would be to military spending and the other half to discretionary spending. Neither side is eager to see this “sequestration” go into effect, but the goal was to create an incentive for Democrats and Republicans to reach a comprehensive budget deal. On top of all this, the new year brings the expiration of certain exemptions for the little discussed alternative minimum tax.

These tax hikes and spending cuts would save the government about $500 billion in 2013. But according to the Congressional Budget Office, this enormous anti-stimulus would push the US back into a recession within the first six month of the year.

While both sides have expressed understandable concern about the long-term budget deficit, it’s these extreme and immediate deficit reduction measures that are most worrying right now. Suzy Khimm of the Washington Post made the point well in declaring that what we have is not a deficit crisis but an austerity crisis.

At the same time, the term “fiscal cliff” misleadingly implies a point of no return. Tax hikes and spending cuts would have an immediate effect on the markets and create an economic drag not long after. But, because all these policies are spaced out over the course of the year, the impact would probably not be overly damaging assuming a deal was reached reasonably quickly.

The major point of disagreement between the two parties is over taxes. And fairly specific details of tax policy at that.

Both sides want to preserve the alternative minimum tax exemptions while letting the payroll tax cuts expire. But they’re divided over the Bush tax cuts. Republicans want to maintain the current rates for everyone while Democrats want to return to the pre-Bush rates for all income over $250,000.

Democrats believe they have the upper hand in negotiations. Polls show that a majority of Americans support letting the high income Bush tax cuts expire. And Obama is just coming off a re-election in which he made this a central issue of his campaign.

Further, if America goes off the fiscal cliff and taxes go up for everyone, then Democrats will argue that Republicans are holding the middle-class hostage in order to protect the top 2%.

But their advantage might not be so cut and dried. If it gets to be early to mid January and no deal is in sight the public could become more concerned with averting a rescission than the exact parameters of the deal. Negotiations could turn into a game of fiscal chicken in which each side hopes the other will blink first.

Republican leadership could also try to gain the upper hand by making a tactical shift on taxes. For instance, propose more modest revenue enhancing measures, such as ending some deductions. The GOP could claim that they were the ones willing to compromise, and then try and pressure Obama into taking a deal much less favourable than the one Democrats are after.

The fiscal cliff negotiations are compelling because they bring together so many of the debates that have been at the forefront of American politics in recent years; job creation, deficit reduction, and economic fairness.

And the ultimate resolution is still so unclear. We could end up with a grand bargain over taxes and government spending. The Democrats using their leverage to force the expiration of the Bush era rates. Or even the two parties simply agreeing to just extend everything, postpone the cuts, and then try again next year.

Luke Freedman is a US election analyst at University of Sydney.

This article first appeared at The Conversation.