The Washington PostDemocracy Dies in Darkness

On tax cuts, Obama decides to fight

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The Obama administration has faced a difficult choice: Does it put off the fiscal crisis looming at the end of the year by capitulating to Republican demands to extend all the Bush tax cuts until 2013 -- a move that would infuriate the Democratic base and muddle the campaign’s message? Or does it stand and fight on fiscal policy, even if that means increasing the chance that markets panic in the most crucial months for the president’s reelection bid?

On Monday, President Obama chose door No. 2, proposing a one-year extension of the Bush tax cuts for families making less than $250,000 and, through his press secretary Jay Carney, promising to veto any effort to “extend tax cuts for the wealthiest Americans.” It’s a strategic decision that could have a tremendous effect on the economy — and thus on the president’s chances in the fall.

Technically, we won’t hit the fiscal cliff — Washington’s preferred term for the near-simultaneous triggering of more than $600 billion tax increases and spending cuts, as well as the predicted point at which we once again hit the debt ceiling — until after the election. But the effects could be felt long before.

The 2011 debt ceiling debate provides an illustrative example. Early in the year, the recovery seemed to be proceeding smoothly. In February, the economy added 220,000 jobs. In March, it added 246,000 jobs. And in April, 251,000 jobs. But as summer approached, and as markets shuddered over the Republican threat to breach the debt ceiling, the economy sputtered. Between May and August, the nation never added more than 100,000 jobs a month. And then, in September, the month after the debt ceiling was resolved, the economy sped back up and added more than 200,000 jobs.

The uncertainty over the debt ceiling may not have been solely responsible for the slowdown in job creation and the drop in consumer confidence. But it surely contributed.

The 2013 fiscal cliff has the potential to be much worse than the 2011 debt ceiling fight, if only because it also includes hundreds of billions in tax increases and spending cuts. The Congressional Budget Office projects that permitting those tax increases and spending cuts to take effect would throw the U.S. economy back into recession — and that’s before factoring in the uncertainty over the debt ceiling.

All this is going to make businesses and investors very nervous. If they begin to expect a possible economic crisis in early 2013, they will start pulling back this year in order to cushion themselves. That could mean layoffs rising and investment falling in September and October — the most important months for Obama’s campaign.

In theory, the Obama administration could head this off by agreeing with Republicans to extend current policy into 2013. Republicans would have some incentive to play ball, as they also lost popularity after the debt ceiling fight. Also, their presidential candidate, Mitt Romney, is facing substantial fire over his tax returns, which have highlighted the ways in which wealthy  Americans can reduce their tax liability, and his tax policies, which further cut rates on rich Americans.

If Obama signed his name onto the upper-income tax cuts in the months before the election, it would effectively take tax rates on the rich off the table in the election, as both parties will agree on the issue, at least through 2013. But with its announcement today, the Obama campaign signaled that that’s not going to happen. And that means no clarity for the market on how — or whether — the fiscal cliff will be resolved until after November.

Some economists think the economy can weather the uncertainty — at least through to the election. ”It’s July now, and early November is soon,” says Wolfers, a visiting professor at Princeton. “While I can see the fiscal cliff having an effect on financial markets and on confidence fairly quickly, it’s hard to see that effect having much of an effect on the real economy prior to the election. Given that, if all you cared about were electoral math, it would make sense to go for the populist policy choice now.”

Others question whether simply putting off the hard decisions would actually calm the markets. “Few believe there will be any kind of progress on this or any other major fiscal issue prior to the election, [so] standing his ground through the election should do no economic harm,” says Mark Zandi, chief economist at Moody’s. “Most important, addressing the fiscal cliff (including the Bush-era tax cuts), extending the Treasury debt ceiling and laying out a credible path to fiscal sustainability should be done together. Addressing them one at a time will create more uncertainty, greater political brinksmanship, and ultimately a much worse outcome for the nation’s fiscal outlook and the economy.”

The administration’s view is that it is trying to defuse the economic uncertainty by simply moving forward on the policies that everyone supports. “We all say we agree that we should extend the tax cuts for 98 percent of the American people,” Obama said. “Everybody says that.  The Republicans say they don’t want to raise taxes on the middle class.  I don’t want to raise taxes on the middle class. So we should all agree to extend the tax cuts for the middle class.”

The calculation among Republicans is that once the middle-class tax cuts expire, they’ll lose their leverage on the upper-income tax cuts. The White House’s hope is that that answer won’t be very persuasive to voters. The GOP’s bet is that it also won’t be very comforting to the markets.