Deficit Reduction: Serial Small-Ball

President Barack Obama and his Democratic congressional allies won the fiscal cliff debate, but will they prevail in the next round of deficit chicken? That’s the question pundits and politicians are asking in Washington.

The early conventional wisdom – that Republicans have the upper hand because of a series of deadlines the president needs to meet – is wrong, I believe. If that is the case, then the next deal or deals will be more “small-ball” efforts like the one just completed.

The president and the Democrats won the fiscal cliff round because they got much of the tax increase on upper income households that the president campaigned on, while avoiding any cuts in entitlement programs.

The final deal – promising only about $630 billion in deficit reduction (plus another $104 billion in interest savings) over the next 10 years – was a far cry from the $2 trillion plus that the president and Speaker John Boehner were discussing only weeks before.  

Enough Republicans apparently read the opinion polls indicating that they would be blamed for going over the cliff that they chose to retreat and fight another day, with these three deadlines seemingly in their favor:

— The deal didn’t include an increase in the federal debt limit, and by early March the Treasury Department should be out of accounting tricks and theoretically no longer able to borrow to fund about a third of government spending. 

— On March 1, roughly 7 percent across-the-board cuts in discretionary spending that were postponed in the fiscal cliff deal go into effect.

— On March 27, the continuing resolution funding discretionary programs expires.

 Swords of Damocles Not What They Appear

These three “swords of Damocles” hanging over the president appear quite threatening, and seemingly should induce him and Congressional Democrats to accept large spending cuts, especially in entitlement programs. The truth, in my view, is otherwise.

Even without a higher debt ceiling, the president can authorize the Treasury to continue paying interest on U.S. debt (though for tactical reasons he may say, up to the very last minute, he can’t or won’t). So there won’t be an unthinkable default.

Likewise, it would be amazing if the president didn’t continue honoring obligations under the big three entitlement programs: Social Security, Medicare and Medicaid. Similarly, it is inconceivable he wouldn’t use any remaining revenue to pay military personnel and war-related costs, though he could suspend payments on contracts for new weapons systems.  

That leaves shutting down the rest of the government, if not in early March, then after March 27, if Congress fails to extend the continuing resolution. The last time Republicans forced a government shutdown like this, they lost and had to back down. I see no reason why they should expect any different result if they try this strategy again.

The only quasi-effective card Republicans may be able to play is the fear of an indiscriminate sequester of discretionary spending. But many in their own party are nervous about this outcome too insofar as it cuts defense.

As for Democrats who want less onerous discretionary spending cuts, they would have to be prepared to make some concessions on cutting entitlements. The president apparently was on board with that idea to a limited degree during his negotiations with the speaker.

From an overall deficit perspective, any trade involving lower discretionary spending cuts for additional entitlements cuts is likely to be a wash, or at best, make only a modest reduction in the 10-year deficit.

 No Carrots Either

If sticks won’t work to induce a large deficit reduction package, is there any chance that carrots will? The short answer here, too, is no.

That is because the president and Democrats already got most of the tax increases they wanted out of the fiscal cliff deal. Any more tax revenue would probably have to come from even greater limits on personal deductions than are in the first deal, which would be highly unpopular.

Meanwhile, the corporate community, which has been open to a business tax overhaul package that lowers rates and reduces preferences, will be on board only if it is revenue neutral. Getting much money from a corporate tax hike, therefore, will be a tough sell, although overhauling business taxes would be worthwhile and may gather steam now that the personal tax issues have been settled.

                       What Next?

 So where does that leave us? The best that probably can be expected in the coming months is another small-ball deficit reduction package. If Congress lifts the debt ceiling only a little at a time, which may be its price for any agreement at all, the likely result is a series of these small deals in Obama’s second term. It is conceivable, though not likely, that these deals will cumulatively add up to the level of savings promised by some kind of Simpson-Bowles-like “grand bargain.”

 The major reasons are that Congress has pretty much exhausted itself in trying to raise revenue. On the cost side, the long-term savings lie predominantly in Medicare, and to a lesser extent in the other two health-care entitlements (Medicaid and the Affordable Care Act), where the politics are especially divisive. At least for the next four years, the best cost savings outcome would be a continuation of the slowdown in health-care cost inflation that has surprised analysts over the past three years.

 The president could change this admittedly pessimistic outlook by embracing the triangulation strategy President Clinton used to achieve welfare reform and apply it to deficit reduction. This would require meeting Republican demands for an overhaul of at least Medicare, if not the other two health-care programs. It is conceivable that the president would want to do this in his final two years to cement his legacy as a transformative leader, but none of the positions the president has taken so far on these issues suggests that this is a strategy he is likely to pursue.

 The country will survive four years of deficit reduction small-ball. Unless health-care cost inflation stays permanently low, however, the nation’s fiscal health eventually will require much more.

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