The battle over the size of the Federal Government in the US is about to be resumed in earnest. I am quite excited about it — this really matters. This is what democracy is for — the peaceful resolution of fundamental differences in society. The forces arrayed on both sides are essentially unchanged from the last battle in 2011. Democrats hold the White House and the Senate with a gain of two seats (55 to 45). The Republicans retain comfortable control of the House of Representatives with their majority shrinking from 50 to 40. About one quarter of the Republican members of the House are members of the Tea Party Caucus (about 60 from 233). Many more Republican members of the House have signed pledges not to increase taxes.
The ‘fiscal cliff’ is a misnomer. Tax increases and spending cuts kick in from 2 January 2013, but the effects will be felt over the whole year, so nothing drastic will happen on the 2 January. The ‘debt ceiling’ deadline of 2011 really was a fiscal cliff because beyond the deadline the US would have defaulted on its Treasury debt which would have had catastrophic effects on capital markets. If agreement is not reached by 2 Jan then tax rises and spending cuts will amount to about 4% of GDP over the whole year. The greater, and earlier, effect on aggregate demand may be from a sharp fall in business and consumer confidence leading into the New Year. If the economy slows markedly then both sides will come under increasing pressure to compromise. But it will not be easy to reach agreement on a question as big as the appropriate size and scope of the Federal Government.
Who has the upper hand in the stand-off that is likely to occur over the next weeks and perhaps into the New Year (over the so-called cliff)? The Republicans have two clear advantages. First, one quarter of their House membership are a group (the Tea Party) that has a return to small government as their founding principle. To thwart tax increases and cut spending is the very reason the Tea Party exists. In contrast, there is no core Democrat group that has single-minded commitment to big government. It will be hard for the Republican leadership to make significant concessions with the Tea Party Caucus threatening revolt unless a hard line is taken. Second, the Republicans, or at least the Tea Party know exactly what they want. They want Federal Government revenue and expenditure to be 18% of GDP or less. They are very clear on this. The Democrats cannot easily articulate what it is they want. The Republicans have a core group within their ranks that sees the struggle over the size of government as existential and they are crystal clear on what they want and what type of agreement will represent success or failure for them. These are crucial advantages in a stand-off. If the pressure comes on to compromise because the economy is stalling, then that clarity and centrality of belief will help the Republicans to hold out.
The Democrats also have two advantages. First, they have a President who has nothing to lose in terms of re-election. That should strengthen the Democrats’ hand. However, President Obama has not shown himself to be very adept at negotiation. Nor has he demonstrated any ability to bring members of his opposition around to his point of view. Not a single Republican voted for the Affordable Healthcare Bill and only three Republicans voted for the his stimulus package in late 2008. You might say those failures simply reflect the partisanship of the Republicans. But recall that no Democrat was more hated by Republicans than Bill Clinton and yet he still garnered many Republican votes for his reforms. Second, the Democrats don’t have to do anything. Most of the changes are tax increases on wealthy Americans. The changes to income taxes, capital gains taxes and alternative minimum taxes will be mostly incident on wealthy households. That is what the Democrats want. Note that the original insistence that the Bush tax cuts should have sunset clauses came from the great John McCain at the cost to him of his own party’s support when he ran for the highest office.
Perhaps the two sides will avoid the fiscal cliff by reaching a grand bargain, such Ronald Reagan and Bill Bradley did in 1986. But I am not confident that is possible in these more partisan times. If there is no agreement by January and both parties come under pressure to compromise,then I expect the Republicans to get more of what they want because of their greater clarity of goals and the existential determination of the Tea Party.