Erratic Progress Toward a Deficit Deal

Bloomberg Government Director of Research Robert Litan

Dec. 19 (Bloomberg) – Despite Speaker Boehner’s latest “Plan B” gambit asking the House to unilaterally extend the Bush-era tax cuts only on incomes below $1 million, the odds still favor a deficit reduction deal before year end or, at worst, in early January after the market tanks and forces the parties (most importantly, reluctant members of Congress from both parties) to sign on.
On the top line numbers, the president and the speaker are actually quite close. The president has reduced his tax demand to $1.2 trillion over 10 years, not far from the speaker’s $1 trillion. The difference in spending cuts (on top of those already baked in under the spending “caps” enacted in August 2011) is even narrower: the president’s $930 billion versus the speaker’s $1 trillion.
Of course, the devil is always in the details, and the close alignment of the top line numbers conceals many differences in the composition of those figures. The best known difference is about the income threshold at which higher personal tax rates apply: $400,000 for Obama, $1 million for the speaker. Any limits that each wants on personal deductions, which will be required to reach any revenue target, have not been publicized. There are also philosophical differences, on Medicare cuts in particular: the president so far insists on cuts falling on providers, while the speaker and other Republicans want cuts in benefits as well.
These differences are real but bridgeable with compromise. If a deal is struck, it wouldn’t surprise me to see  a lot more detail than just the headline numbers on higher taxes and entitlement savings. The two sides want to convince the markets that any deal will be real, and that requires specifics, while still leaving many details to be worked out by Congress next year.
Bloomberg Government has been following all this in a series of reports on the business impact of deficit reduction. Several highlights deserve mention:
• The apparent deal in the making — which may come in just under $5 billion (counting the defense savings from the wind-down in war spending) — will slow the rate of increase in federal debt, but not enough to stabilize the important ratio of debt-to-GDP. To do that, a $6 trillion package would be required.
• Nonetheless, the potential Obama-Boehner deal should reduce pressure on credit markets, eventually reducing interest rates by about one-half percent, saving corporations more than $60 billion in annual interest by 2022, while boosting equity prices by a little more than $1 trillion (Some of that boost may already be reflected in stock prices, and would more than evaporate if a deal is not approved and the nation goes over the dreaded fiscal cliff).
• There will be plenty of pain to go around. Many of the nation’s 140,000 prime contractors with the federal government will lose revenue (though small business contractors, who collectively are guaranteed a 23 percent share of the government’s business, should fare better than many larger contractors).
• Any increase in the top marginal rate will hit less than 5 percent of the nation’s small businesses, and only to a moderate degree. Academic studies indicate a weak link, at best, between tax rates of these magnitudes and business hiring.
• Corporate tax reform — broadening the base and lowering the rate — will be a lot harder to achieve than many think. Lawmakers would have to eliminate $125 billion in business tax preferences over 10 years just to pay for each one percentage point reduction in the corporate tax rate (currently 35 percent). It’s unlikely that the Obama-Boehner deal will tackle the corporate income tax, but expect lawmakers to try during 2013.
No one ever said reducing the deficit would be easy. The pre-Christmas spirit of compromise (a dreaded word among the committed, but necessary to get anything done) hopefully will last long enough to produce a deal that at least will start the country on the path back to fiscal sanity.

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