WASHINGTON -- As the week winds down with lawmakers and the White House still at odds over dueling proposals to avert the fiscal cliff, a growing number of voices in the debate are suggesting that the year-end deadline could pass without a deal, initiating a set of across-the-board tax increases and automatic spending cuts.
Add to those Mark Zandi, chief economist with Moody's Analytics, who testified before the congressional Joint Economic Committee on Thursday and urged lawmakers to hammer out a comprehensive agreement that not only addresses the near-term tax and spending challenges, but that extends to the broader issues of the federal borrowing limit and structural overhauls to address long-term deficits.
"I would not come up with a deal unless it's a really good deal before the end of the year. I would take it into next year if that means you're going to get a better deal," Zandi said. "I think this has to be done as a package. I don't think you can break this apart, because it's just going to create brinkmanship, angst."
Thursday's hearing comes after President Obama and House Speaker John Boehner (R-Ohio) have presented their plans for avoiding the tax increases and spending cuts that, if enacted in full, could derail the fragile economic recovery, economists have warned.
The White House is proposing a plan that calls for $1.6 trillion in tax increases over the next 10 years, including an increase in rates for the top 2% of earners, as part of $4 trillion in overall deficit reductions. Republicans have countered with a plan for $2.2 trillion in deficit reductions that outlines revenue increases of $800 billion achieved though phasing out exemptions and capping deductions, but leaving marginal rates where they stand for all earners.
Each side has complained that the other's plan is unbalanced and short on specifics, and Obama and Republican leaders have not met since last month, though the president and Boehner have spoken on the phone. But in their public remarks, Obama and other top Democrats have been adamant that there will be no deal unless Republicans concede to top marginal tax rates going up. "Until there's some movement on tax rates I'm not talking about any other proposals," Senate Majority Leader Harry Reid (Nev.) told reporters Thursday afternoon.
Though some GOP members and conservative commentators have begun to suggest that Republicans should accept Obama's proposal to vote for an extension of the current low rates for all but the top 2%, Boehner has maintained that rate increases are a non-starter for his caucus.
The debate is particularly relevant for financial advisors, whose clients could face a very different investment landscape in 2013 depending upon how the government acts. In addition to the scheduled increase in marginal rates for ordinary income, the top tax rate for capital gains would increase from 15% to 20%, while dividend income would align with ordinary-income rates, for a top rate of 39.6%. (For top earners, both types of investment income would be subject to an additional 3.8% Medicare surcharge as part of the president's health-care law, unrelated to the fiscal cliff talks.)
Just as the president has objected that Republicans won't give ground on tax rates for top earners, Republicans have complained that the administration is too narrowly focused on revenues and unwilling to make needed cuts to federal spending in programs like Medicare.
Sen. Pat Toomey (R-Penn.) took issue with the $600 billion the White House claimed its plan would cut in spending. "When you drill down, it looks like there's much less even than that in the spending restraint," Toomey said at Thursday's hearing, asking a conservative witness whether the president's proposed tax increases could throw the economic back into a recession.
"It's not only likely, it would certainly do so. In fact, the dividend tax increase alone is positively cataclysmic," said Kevin Hassett, senior fellow and director of economic policy at the American Enterprise Institute. "That's ridiculously bad news for equity markets."
Taken together, the tax increases -- or even the potential that rates may rise -- have a chilling effect on corporate investment, which could ripple through the markets, Hassett warned.
"I think the threat of those increases is a very big, significant negative," he said. "The fact is that dividend taxes, capital gains taxes, statutory tax rates have a big effect on investment through the use or cost of capital. If the dividend tax is going to go up, then there are a lot of firms that are going to be hurt significantly by that, and day-to-day would be paring back their capital spending in anticipation of higher taxes in the future."
Hassett and Zandi's comments followed another week of posturing as leaders from both parties blasted the other for failing to offer a serious plan, and the Office of Management and Budget began directing federal agencies to begin to plan for the impact of the potential spending cuts.
In the meantime, the showdown over the fiscal cliff is beginning to bleed into the next major fight in Washington, as the government will again reach its borrowing limit early next year. In his initial proposal, Obama suggested that Congress cede its authority over raising the debt ceiling to avoid a repeat of the standoff that played out last summer, when the ratings agency Standard & Poor's downgraded U.S. debt and markets lurched through a period of high volatility.
Senate Minority Leader Mitch McConnell (R-Ky.) rejected that proposal out of hand.
"Look: the only way we ever cut spending around here is by using the debate over the debt limit to do it. Now the president wants to remove that spur to cut altogether. It gets in the way of his spending plans," McConnell said Thursday on the floor of the Senate. "I assure you: it's not going to happen."
(In a bit of political maneuvering, McConnell proposed a vote on Obama's debt ceiling plan, likely expecting Reid not to comply for fear of subjecting vulnerable Democrats to a tough vote. But when Reid offered to bring the bill to the floor on Thursday, McConnell blocked debate with a filibuster.)
There is broad agreement that the uncertainty over the spending cuts and tax-rate fluctuations involved with the fiscal cliff and the concern that the United States could default on its debt payments if the borrowing limit is not increased is a drag on markets and consumer confidence. Zandi is quick to add that a long-term plan for fiscal responsibility that includes reforms to the tax code and entitlement programs must also be part of the solution.
But with a Dec. 31 deadline, time is running short, especially for the sort of grand bargain that Zandi sees as necessary. Asked whether that could be accomplished by the end of the year, Zandi replied, "No. I'm skeptical. But I do think it can be done before -- early next year before it does significant economic damage."
But it won't be too long into 2013 without a deal before things get serious, he warned.
"I think you could go into early February," Zandi told lawmakers. "By early February if it looks like you're not coming to a deal, and the market investors begin to discount the likelihood that you're not coming to a deal, then you'll see stock prices decline, the bond market will react, consumer and confidence will begin to erode. By mid-February it would be doing a lot of damage, and by the end of February, of course, then the debt ceiling again. You can't navigate around the debt ceiling and really bad things will happen. So I think you've got about a month."
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