As the elections come close we are all focused on the results, and on who might control the U.S. House and Senate, as well as the Presidency. If President Obama is re-elected the lame duck session of Congress will be dealing with the so called fiscal cliff, with the expiration of the Bush tax cuts and the impending “sequestration cuts” arising from the failure of the so called super committee. So the country is faced with tax increases for all, and a deep cut in spending at the same time, taking critical dollars out of the economy. Some data from the Congressional Budget Office:

Taken together, CBO estimates, those policies will reduce the federal budget deficit by $607 billion, or 4.0 percent of gross domestic product (GDP), between fiscal years 2012 and 2013. The resulting weakening of the economy will lower taxable incomes and raise unemployment, generating a reduction in tax revenues and an increase in spending on such items as unemployment insurance. With that economic feedback incorporated, the deficit will drop by $560 billion between fiscal years 2012 and 2013, CBO projects.

Congressional Republicans would be delighted with the spending cuts, except for the defense sequester, which is raising howls of protest from the neo-con/Republican defense hawks. So the Republicans want to roll back ALL of the cuts, in the hopes of saving the defense spending. So much for Republican deficit cutting bona-fides. But I digress. Lets look at the politics.

The Democrats have dug in pretty hard on the extension of the Bush tax cuts for the top earners. The Republicans have dug in pretty hard as well, opposing any attempts to raise rates on those top earners. Republicans have had the advantage legislatively up to this point, and forced through a full extension of the Bush tax cuts that the President signed in 2010. That extension was for two years, and I do believe that Barack Obama, if re-elected, will be able to get the Bush tax cuts extended for all but the top earners. How will he do that? I think it will be done in cooperation with House Speaker John Boehner.

Speaker Boehner has recognized that any grand bargain on the budget/deficit will require additional revenues. His willingness to accept up to $800 billion (ten year number)in new revenue during his negotiations with President Obama drew howls of protest from his own Republican caucus, and was one of the reasons that the negotiations failed. Boehner was pushed around by Leader Cantor on the issue, and the President was pushed around by Democratic Congressional leaders. Since Boehner can agree to nothing that would cede ground on the Bush tax cuts for the top tier there is no realistic way to reach agreement on extension in the lame duck session, short of agreeing to kick the can down the road for a few months. That will be a difficult sell in the U.S. Senate. There is no time for tax code reform that would raise money (Boehner’s preferred methodology)since that work could take a year. The Democrats hold two cards (defense spending, and the Bush top tier tax cuts) and will not give them up lightly. What is a Republican to do?

If the President is re-elected then my guess is that a phony lame duck session negotiation will fail, followed by a plunge off the cliff, and a “quick” deal that extends the Bush tax cuts for all but the top, restores the defense sequester, pays lip service to tax reform by ordering the appropriate Congressional Committees to produce a reform package within a prescribed period that could simplify and lower marginal rates (Simpson-Bowles), and gives Republicans additional (domestic) spending cuts as well as some (future) deal on entitlements (to correspond with tax reform package) Still a tough deal for Boehner, but he can sell the tax package as a “tax cut” after the plunge off the cliff, and may be able to deliver some immediate and painful spending cuts that his caucus is salivating for. Ultimately he will tell his caucus that the issue was decided by Obama winning re-election, and that they have to take the best deal they can get. The Democrats do not hold all the cards, as the debt ceiling will need to be increased, and that will be a major source of Republican leverage. That will be a part of this negotiation, as the government will likely hit the existing debt ceiling in the first quarter of 2013. Talk about a fiscal cliff. This is the Grand Canyon. Can a deal be reached without initially going over the cliff? Absolutely possible, but just so much more difficult for John Boehner. But he will extract some real spending concessions from a newly elected President Obama in the process, and there will be a deal, because there has to be a deal.

So what happens if there is a President Mitt Romney? Oh boy, that has to be another post.

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