The Fiscal Cliff

Congressional leaders are no closer to reaching agreement on a plan that would forestall the Fiscal Cliff,  the popular term for the effects of the Budget Control Act of 2011, which will go into effect Dec. 31 if a deal is not made. Cuts would come to over 1,000 government programs, the payroll tax would jump 2%, and tax breaks for businesses would end, among others.

Three Lehigh professors from the College of Business and Economics offered their thoughts on the Cliff, and how public bickering, smart taxpayers, and closing loopholes are major factors in what we can expect during a potential resolution.

Parveen Gupta, Professor and Chair of Accounting 

One of the hallmarks of our financial markets in the U.S. has been that the government always tried to provide certainty in the markets. It’s why, historically, U.S. financial markets perform well, and why the world invested in them. Politicians understood the importance of not rattling the markets, providing traditional certainty to them. This used to be one of the distinct advantages of U.S. financial markets and politicians were cognizant of it.

Lately, and perhaps beginning with the start of the debt ceiling debate, that mindset has gone out the window. Politicians are too married to their extreme positions and no longer understand their most pressing issue is to ensure certainty. This back and forth debate rocks that. Yes, the debt ceiling issue was resolved. But the precedent keeps being strengthened.

I’m not saying politicians shouldn’t fight for what they—and their constituents—believe in. Still, they are creating more uncertainty than necessary, and that’s going to hurt our markets longer term.

I am sure that sooner or later we will reach compromise, but the process itself is as important as the final decision. I know making sausage is not pretty. But I don’t want to show how we make sausage to the rest of the world.

We no longer live in an environment where everything we do will just work. Nations are rising up. We must be careful how we debate. Let us not take our attention away from the process. Provide confidence. Politicians in the U.S. are, are should be, very well aware.

I suspect that tax increases, whether a result of the fiscal cliff or a negotiated deal between Congress and the Administration ,will result in behavioral changes to mitigate the tax effects. For example, if dividend rates rise from 15 percent to 43.4 percent then it would not surprise me if share buybacks replace dividends to a significant extent. Similarly, the use of deferred compensation vehicles will rise as well.

A comprehensive tax reform that deals squarely with some of the more egregious areas of the tax code - for example, the carried interest loophole for investment managers and the taxation of foreign earnings for corporations that results in billions of dollars of cash stuck overseas - is needed, as well as entitlement reform. The current state of affairs is unsustainable, yet neither party is willing to confront reality. President Obama has not helped matters with his divisive rhetoric about “fair share. The middle class is being hammered and still harbors enormous resentment over the bailouts. It's one thing to pay for quality government, it is quite another to pay to clean up someone's mess.

So far President Obama has shown very little willingness to compromise. He feels no doubt emboldened by the recent election, as though he has a mandate from the American people to get his way, to win. Unfortunately he misinterprets the election. He does have a mandate, but it’s not to win or to get his way. Rather, he has the same mandate every returning member of Congress, Democrat or Republican, has and that is to put the country first, to compromise and get a deal done. Not at the 11th hour, not after the New Year, but now so the economy doesn’t continue to get jerked around. President Obama’s proposal to avoid the Cliff is overreaching, his priority is a personal win, not a win for the country. John Boehner’s proposal shows compromise and at this point he appears to be willing to put the country ahead of achieving a victory for himself or his party. 

President Obama seems to embrace drama.  He likes the long, drawn out crises. Based on Speaker Boehner’s proposal, it’s already clear the President can get a win, but not everything he wants. So what is the President waiting for, a bigger audience, or for the other side to give him a total victory? If it’s the latter he may lose any chance of a deal. Republicans may choose to allow taxes to rise on the top 2 percent and let the sequester kick in on January 1st as Tennessee Senator Bob Corker has suggested. The problem is that while the sequester will cut $100 million from discretionary spending, the real causes of our deficit problem, entitlements, are largely protected.

So while some cuts to spending are better than none, and raising taxes on the wealthy is better than raising them across the board, neither is the best solution. This brings us back to a deal, and the best one is similar to the one Speaker Boehner has offered: Increased revenue from closing tax deductions for the wealthy and real entitlement cuts. I’m hopeful that President Obama will see the light and get in the mood to play “Let’s Make A Deal.” In the meantime, the country pays the price.