Fiscal Cliff

The GOP's Secret Leverage in the Fiscal Cliff Negotiations

Who actually has the leverage in negotiations over the fiscal cliff-and the extension of Bush-era income tax cuts in particular?

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Who actually has the leverage in negotiations over the fiscal cliff—and the extension of Bush-era income tax cuts in particular? On the surface, it might look like Democrats, who control the White House and the Senate, have the upper hand. But House Republicans may have more leverage than is immediately apparent.

Right now there are two competing theories about the fiscal cliff negotiations.  The first says that President Obama has the most leverage. His party controls the Senate, and he has to sign off on any deal. He has the bully pulpit, and he has argued extensively that the election was to a large extent about raising taxes on top earners. More importantly, the policy landscape favors raising taxes on top earners. Because the Bush-era tax rate cuts expire automatically, all President Obama actually has to do is wait. Taxes will go up automatically on everyone. At which point it should be even easier to get Republicans to agree to lower taxes on income below $250,000 a year.

That's the basic logic underlying GOP Rep. Tom Cole's argument that the best way for Republicans to move forward is to fold quickly, by agreeing to extend the Bush tax cuts for all but top earners. Doing so, he says, would rob Democrats of a crucial argument: that Republicans are holding up an extension of the middle class tax cuts in order to protect the rich from a tax hike. Republicans could then negotiate tax rates for top earners separately. And even if Republicans couldn't get a deal to keep current tax rates for top earners, allowing their taxes to go up would only give Obama half a loaf: The president has asked for $1.6 trillion in new tax revenue. Letting rates rise on top earners would raise a little less than $1 trillion.

In theory, then, President Obama has it easy: If he does nothing, he'll eventually get what he wants. So why would he sign any deal that doesn't raise taxes on high incomes?

The answer is that he and his economic team believe he needs to sign a deal—any deal—in order to prevent an economic calamity.

Which brings us to the second theory about who really has the leverage, espoused most recently by Hudson Institute fellow and former Bush administration econ adviser Keith Hennessey. Hennessey argues that the White House believes that without a deal to avert the fiscal cliff, the U.S. will enter a new recession next year. That recession would not only be bad for the country, it would also substantially hamper President Obama's ability to accomplish his larger policy agenda, especially on budget issues. It wouldn't even matter much who got the blame for the recession. "President Obama's veto threat decision is not just about fiscal policy, and it's not just about who gets blamed for a legislative failure," writes Hennessey. "It's about whether the President wants to cause a recession in 2013 and hamstring his second term." So when President Obama says he'll veto a bill without tax increases, he's just trying to push the GOP. But he's not actually committed to a veto. 

Hennessey isn't the only one who thinks that fear about the economy will trump other leverage. Bloomberg columnist Josh Barro has also argued that the Obama administration won't risk another recession caused by the failure to make a deal. The political costs would simply be too high.

So is President Obama bluffing? We already have a pretty good clue to how the White House will act—not what the administration is saying now, but how it actually acted in 2010, the last time the Bush tax cuts were set to expire. Then, as now, doing nothing would have allowed tax rates to rise. And then, as now, the president insisted that he would not extend the Bush tax cuts for top earners. But he did anyway.

Asked at a press conference earlier this month why this time would be different, President Obama suggested that the economy was better this time around. In fact, it's growing at the same pace. Which is to say that Obama didn't have a very good answer, because this time isn't all that different. And while a different outcome is possible, especially if the GOP follow's Rep. Cole's advice, it's not the most likely scenario.