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Over the Cliff? A Better Deal Would Be Worth the Wait

Will we get an agreement on the “fiscal cliff” before year’s end? Even after Friday’s developments, which included a meeting of congressional leaders at the White House, I really don’t know—and neither does anybody else. But when the deal materializes still matters less than what the deal entails.

Let’s review what happens on January 1, at least officially, if Congress and President Obama don’t act:

Tax rates on all incomes would return to what they were during the Clinton era, before the Bush tax cuts reduced rates. Automatic spending cuts to a wide variety of agencies, including the Pentagon, would take effect—a punishment Congress imposed upon itself, by failing to find alternative spending cuts that it had vowed, in 2011, to find. Extensions of refundable tax credits for the working poor, families with children, and people paying college tuition would expire, as would an emergency federal program that provides extra unemployment benefits and a temporary reduction in payroll taxes. Medicare would reduce what it pays doctors and income tax filers would have to consider whether they fall into the “alternative minimum tax,” resulting in substantially higher liabilities.

Lots of people would feel the impact personally—their paychecks would shrink, government services would become less available, and so on. In addition, the policies as a whole would reduce the money going into the economy, causing it to slow down and quite possibly fall back into recession. That’s obviously not an outcome anybody wants. 

But would all of these things happen right away? Is January 1 truly the make-or-break date that so many politicians and pundits seem to think? That’s a lot less clear.

The administration has already instructed federal agencies to keep spending money as if the old, 2012 authorizations were still in effect. (For this reason, the Huffington Post's Ryan Grim has likened the fiscal cliff to the Y2K scare.) The Internal Revenue Service, for its part, has not yet issued instructions on how to change withholding calculations for personal income taxes. The IRS has said it’d offer guidance by year’s end, which presumably means Monday. But even if the IRS produces new withholding guidelines, employers and payroll companies would need time to adjust their systems—in many cases it would take a payroll cycle or two, maybe even more. The Labor Department could pay those extended unemployment benefits retroactively, as it has done in the past.

That’s not to say January 1 is meaningless. While getting jobless benefits retroactively is better than not getting them at all, it’s not much help if your rent is due at the beginning of the month. Even temporary reductions in Medicare pay could convince doctors to see fewer patients, making it harder for seniors to get medical attention, at least for some period of time. The spectacle of congressional action could also scare consumers, investors, and employers—weakening a recovery that isn’t all that strong in the first place. That’s obviously not an outcome anybody wants. 

But, if you’re a Democrat, holding out past January 1 has its upsides. Once the Bush tax cuts come off the books, the baseline for budget calculations changes: Bills preserving Bush-era rates on lower and middle-incomes, while restoring Clinton-era rates on upper incomes, would become tax cuts rather than tax increases. It's a purely semantic distinction, for sure, but it could win over reluctant Republicans. In addition, the House on January 3 votes for its leadership—and whether to reelect John Boehner as speaker. After that date, Boehner could more easily defy the most conservative members of his caucus, whose opposition could prevent him from serving as speaker again.

And then there are the polls, which suggest that the public overwhelmingly blames Republicans, rather than Obama, for inaction. Polls don’t always predict how people will react to actual political developments in real time. But chances are good that, the longer it takes for a deal, the more pressure Republicans will feel from the voters—not to mention their supporters in the business community—to abandon their opposition to tax increases and determination to cut entitlements.

Do Obama and the Democrats get that? It’s impossible to know. But Friday’s news was at least a little bit encouraging. During the White House meeting, Obama apparently offered no new concessions. Instead, he made a new demand: If weekend talks between the parties break down, Obama said, he wants both houses to hold an up-or-down vote on a Democratic bill. Later, Senate Majority Leader Harry Reid announced he wanted to bring just such a bill to a vote on Monday. Not only would that bill raise rates on annual household incomes above $250,000 and extend jobless benefits for the long-term unemployed; according to a senior Democratic aide, the bill would also extend those critical tax breaks for working families and children. (The bill would also put off the cut in Medicare physician payments, according to the aide. Extending the payroll tax holiday seems to be off the agenda, to my great chagrin.)

Senate Minority Leader Mitch McConnell might filibuster such a bill anyway; even if he didn't, Boehner would be unlikely to hold a vote on it, at least right away. But Obama's demand and Reid's cooperation suggest the Democrats want to apply pressure and are willing to hold out a little longer—that they understand a mediocre bill on December 31 is worth less than a good bill on January 4.

Update: Matthew O'Brien of the Atlantic has a terrific summary of how the tax effects of the fiscal cliff would affect different taxpayers.