A Fiscal-Cliff Primer

COMMENTARY Budget and Spending

A Fiscal-Cliff Primer

Dec 13th, 2012 4 min read

F.M. Kirby Research Fellow in National Security Policy

Jim Talent is a Distinguished Fellow at The Heritage Foundation.

It’s time for a status report on the state of negotiations over the fiscal cliff. Here are some frequently asked questions and answers.

1) Q. What is the fiscal cliff?

A. Under existing law, $494 billion in tax increases are scheduled to go into effect on January 1, 2013. There are three main categories of tax increase that are coming. About a third of the increase will come from ending the Bush tax cuts. Those included across-the-board income-tax cuts, reductions in capital-gains and dividend taxes, a reduction in the marriage penalty, and an increase in the child tax credit. About a quarter of the tax increase will come from ending the payroll-tax cut established as a temporary measure several years ago. About a fifth of the increase will come from ending a “patch” that minimized the effect of the Alternative Minimum Tax on the middle class. There are a number of other smaller tax hikes scheduled to go into effect, including a big increase in the estate tax that will produce only $13 billion in revenue but will destroy a lot of family farms and small businesses.

The cost of getting married, and of dying, is about to go up. For a full discussion, see this report.

2) Q. How big would this tax increase be?
A. It would be a $500 billion increase in one year. That’s almost as big as the tax increases imposed by Obamacare over a ten-year period.

3) Q. What’s the official position of the Republicans on the scheduled tax increase?

A. They want to avoid raising taxes on anyone.

4) Q. What’s their real position?

A. See the answer to question 3 above.

5) Q. What’s the official position of the Democrats?

A. They want to continue the tax cuts on middle-income taxpayers and to raise tax rates on higher-income taxpayers.

6) Q. What’s their real position?

A. They want as much tax revenue as they can get. They also believe that next year they can reinstate any of the tax provisions they decide they like. So they believe that, by allowing the country to go over the cliff, they will collect a huge amount of new revenue that will relieve the pressure on them to cut spending, while still being able to reenact later a few of the smaller tax benefits that actually appeal to them.

7) Q. Aren’t the Democrats afraid of the political backlash if they allow taxes to go up on everyone?

A. They’ll blame the Republicans.

8) Q. Can they get away with that?

A. They think they can. Read the polls.

9) Q. Don’t the Democrats realize that tax increases will discourage consumer spending, cut small businesses’ investment, kill jobs, and therefore produce nowhere near the revenue projected by their static model of budgeting?

A. Are you kidding?

10) Q. Can’t the House Republicans stop the tax increases by passing a law on their own?

A. Read Articles I and II of the Constitution.

11) Q. Are there any spending reductions scheduled to go into effect?

A. Yes. The “sequester” will also begin on January 1. The sequester was enacted as part of the budget deal in 2011. The sequester imposes approximately $1 trillion in spending cuts with entitlement spending almost completely exempted. Half of the cuts — almost $500 billion — will come out of the defense budget, even though defense spending is only about 16 percent of the budget. If the sequester goes into effect, the defense budget will be cut by $50 billion next year alone.

12) Q. What will be the effect of the defense cuts on the military?
A. Secretary of Defense Leon Panetta has said it would be “devastating.” The chairman of the Joint Chiefs of Staff has said it would be like “shooting ourselves in the head.” The cuts will also cost more than a million jobs around the country and cause lasting damage to the defense industrial base.

13) Q. The sequester does contain some cuts to non-defense discretionary spending. Don’t the Democrats want to prevent that?

A. Not as much as they want higher taxes. Besides, since they control most of the government, they figure they can restore the spending next year and perhaps even increase it because of the additional revenue they expect.

14) Q. So what leverage do the House Republicans have in their negotiations with the president?

A. See the answers to questions 6–10 and 13. In addition, the president has a major advantage because the fiscal-cliff issues are coming up outside of the regular budget process. He can isolate the tax issue without having to answer for his failure to propose real budget reform.

15) Q. What should the House Republicans do?

A. Stop wasting valuable time by counting on negotiations with people who won’t advance a serious plan. Actually begin legislating their agenda. Pass a bill out of the House that postpones all the tax increases as well as the defense cuts for one year. Use the debate on that bill to make a case to the public. Make the defense cuts and tax hikes, and the resulting job loss, a major issue. If the Senate Democrats don’t take up the bill, their failure to act will become an issue. If they do take up the bill, Republicans in the Senate can make the economy and the defense cuts a major point of debate.

If the Democrats take action to postpone at least the defense sequester, that will be an important point gained. If they don’t, then they and the president will clearly be responsible for the damage to national security and the job losses in the defense industry.

In addition, Republicans should begin preparing for next year. Republicans should announce that under no circumstances will they agree to a debt-limit increase beyond the next session of Congress (which ends in the fall of 2013) without real budget reform. Next year, the advantage will shift to Republicans. They already have a good budget plan (the Ryan plan). They can work on tax reform that will create jobs by reducing rates — wherever rates are at that point — and reforming deductions.

In the first three months of next year, the president will have to make an inauguration speech and a State of the Union address and propose a budget. That will be the time when maximum pressure can be applied on the administration to propose real entitlement reform, which will expose the divisions within the Democratic party and be the first real step toward actually reducing the deficit.

Whether this plan will work depends on how much it moves public opinion. But it’s the best chance to avoid a loss on taxes, and it offers real hope of preventing irreparable damage to national security and getting a budget plan next year that will prevent national insolvency. The stakes are too big for Republicans not to try.

— Jim Talent is a former member of the Senate Armed Services Committee and a fellow at the Heritage Foundation specializing in military affairs.

First appeared in National Review Online.