Fiscal Cliff Deal Raises Taxes, Delays Sequestration…And Will Cut Spending!

The so-called fiscal cliff—that combination of automatic tax hikes, expiring tax breaks, and supposedly ironclad cuts in government spending—has been averted. Who says government can't get anything done? Not only did president and both houses of Congress pull together at the very last minute to designate Salem, Massachusetts "the birthplace of the National Guard" (seriously), they also managed to:

• Keep income tax rates the same for most Americans. People making over $400,000 as individuals and $450,000 as joint filers will see their top rates go back to what they were under Bill Clinton. Capital gains taxes for the wealthy go up and personal exemptions for those making $200,000/$250,000 are subject to new limitations. The Alternative Minimum Tax (AMT), originally designed to capture a handful of millionaires during the Nixon era, has been "patched" so it no longer snags an increasing number of households.
• End the payroll tax holiday, which allowed wage earners to keep 2 percentage points of FICA taxes for Social Security. That means all people earning a paycheck will take a hit on the first $113,000 or so of wages.
• Create a one-year "doc fix" so physicians handling Medicare patients will be paid more than they would if previous law (passed in the 1990s) was allowed to go into effect; extend a ton of tax breaks and supposedly stimulative tax policies to small sub-groups; delayed implementation of supposedly mandatory "sequestration" cuts to defense and other programs; and more.
• Keep extended and emergency unemployment benefits going for another year without any offsets.

Go here for a full rundown of the details by the Tax Policy Foundation.

It's a rotten deal, filled with precisely the sort of sad-sack posturing that we've come to expect and maybe even demand from our elected officials. But I am confident for two reasons (explained below) that this whole episode will mark the high-water mark of out-of-control government spending at the federal level. That's despite the best efforts and worst intentions of big-government Republicans and Democrats alike.

Despite all the drama and handwringing, the final package passed pretty easily, with large majorities in the Senate and House going for the bill. In the Senate, only eight voted against (including Tea Party faves Sens. Rand Paul, Mike Lee, and Marco Rubio) and in the House, folks such as Rep. Paul Ryan fell in with the party leadership to say aye. Some House members said no way, including Rep. Justin Amash (R-Mich.), Sen.-elect Jeff Flake (R-Ariz.), and Rep. Jason Chaffetz (D-Colo.) (R-Utah). Characters such as Sen. Tom Harkin (D-Iowa) voted against it because it didn't tax the wealthy enough (I disagree with him but admire his willingness to vote his conscience). A more thorough account of the votes for and against is here.

Alot of Republicans and Republican-friendly folks are claiming this as a victory (because Obama had originally set his mind on raising tax rates on lower levels of income) or the best deal that could be had given the circumstances (i.e., a hapless Republican leadership). The least convincing in this line of thought comes from libertarian Grover Norquist of Americans for Tax Refrom, who says that voting for the deal means "we're not raising taxes." On the other side of the aisle, many liberals and those further left are, like Harkin, livid that Obama caved quickly on income levels and didn't put in more spending provisions in whatever deal he struck.

Is a bad deal—from whatever angle—better than no deal at all? That remains to be seen, since this deal really doesn't set anything in stone. First and foremost, there are large budget issues that have not been addressed in any way, shape, or form. The federal government has not passed anything resembling an actual budget in over three years. That process—back when it actually happened—starts soon in the new year. While both the president and the GOP-controlled House have produced their legally mandated documents, the Senate Democratic leadership has refused to execute what is arguably its most basic function. The result has been a government run on continuing resolutions (not a bad outcome, if you dislike spending; government expenditures have essentially been flat since 2009, when they ratcheted up dramatically due to last-minute Bush admin actions such as TARP and first-rush Obama initiative such as the stimulus). The government has also just about reached its debt limit again, too, which means that Congress needs to again raise the limit of money the feds can borrow. The last time that happened was in the summer of 2011, which gave rise to the plan that helped create sequestration.

So the government has effectively kicked the can so far down the road that they've run out of road. That's quite an accomplishment but it's one that will be very short-lived (the feds seem capable of always building more roads than they need; bridges too). We will be in the same sort of impasse that we've been at for years now. The problem is usually denigrated as gridlock and laid at the feat of historically obstructionist Republicans. But none of that is true. Congress has been able to pass all sorts of stupid and generally terrible legislation under Obama and the fiscal cliff deal, whatever its particulars, merely underscores that fact. The true obstructionists in Congress, at least when it comes to budget issues, are the Senate Democrats who haven't completed any serious work in years. More specifically, the blame falls to Majority Leader Harry Reid of Nevada and budget committee chairman Kent Conrad of North Dakota. After a decades-long career in which he is inevitably held up as a great statesman—despite his inability to produce, much less push through, a budget—Conrad is finally retiring. So maybe that will change finally.

At this point, the only interesting questions for the next couple of months are these:

1. Does Obama and the Democrats' extension of the Bush income tax rates for 99 percent of taxpayers represent an upper limit on federal revenue? We live in an era of trillion-dollar deficits and hollow insistence that spending isn't the problem (indeed, barely a day can go by without Paul Krugman or someone like him bleating that the real problem is government spends too little). Now that Obama has ratified a revenue plan, is that the upper limit of income we can reasonably expect the feds to live within? If the GOP can't make that case, they are even sadder than they look.

2. Will spending finally be a front-burner issue? There is no reason to think that stimulus—or massive government-spending more generally—works to "jump-start" an economy. Indeed, there are many reasons to acknowledge that the opposite is more likely to be true. Now is exactly the moment to be discussing serious year-over-year cuts in spending. Obama is still pushing the line that he believes in a "balanced approach" to budgeting. Late last year, he defined that as $2.50 in spending cuts for every $1 in new tax revenue. While that ratio is certainly too small (Canada reduced its debt-to-GDP ratio and goosed its economy in the 1990s by cutting $6-$7 for every $1 in revenue), it represents a starting bid in a process that could lead to a smaller government and a bigger economy. If Republicans insist that defense spending not be cut (they've flipped out over minor trims to a year or two of defense reductions), they have already lost not just this battle but every fight they'll be in until they disband as a party. Nor is it any good to say that all cuts will come from poverty programs (however ineffective, inefficient, and counterproductive some of them may be) or from entitlement spending circa 2020 or later.

Here's why I'm hopeful that the next few years might actually swing toward smaller government spending and reductions in debt—and as a result, a better economy. Over the past several decades, real per-capita spending outlays have followed a predictable though generally ignored pattern: They go up under Republican presidents and stay flat under Democratic ones. Liberal and conservative partisans don't want to acknowledge this because it's the exact opposite of what they sell to the voting public. The GOP is the party of skinflints and the Dems are the crew that stands for massive handouts, right? Well, no:

Obama got his bump up during his first year or so in office. Part of it was due to George W. Bush greasing the skids by bailing out the big banks and GM and Chrysler, part of it due to Obama's decisive win over John McCain. But even his re-election hasn't given him political capital to spend after a first term spent pushing through a still-unpopular health-care plan that's gonna be a total bear to implement over the next couple of years. And everyone knows he's got no second-term agenda (if he had, we would have heard about it sometime during last year's campaign, wouldn't we have?).

Anything can happen of course. You can't underestimate the lack of vision and leadership represented by Mitch McConnell and John Boehner and Harry Reid. But we can now estimate what federal tax rates are gonna be for the next several years, so we know how much money the feds will have to play with. The only thing left to do is to focus on the spending side. And there's nowhere to go but down on that side of the ledger.