How to approach the 'fiscal cliff'
Keep payroll taxes low and fight for entitlement reform.


A motorcade with U.S. President Barack Obama drives towards the U.S. Capitol in Washington November 21, 2012.

Article Highlights

  • Tempting as it might be, the GOP should resist minimizing the very real consequences of going over the #fiscalcliff.

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  • If there’s no #fiscalcliff deal, and economic turmoil ensues, the president’s second term will be irrevocably damaged.

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  • The GOP is clearly committed to keeping taxes as low as possible for all taxpayers writes AEI’s Jim Capretta.

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  • The hardest part of the #fiscalcliff negotiations will be the battle over entitlement reform.

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Negotiations between congressional Republicans and the White House will intensify this week as the deadline for steering clear of the year-end “fiscal cliff” approaches. Like the 2011 showdown over the debt limit, these talks will be a high-stakes affair for both parties, with the potential for lasting political effects. With so much at stake, how should the GOP approach the talks? The following are a few suggestions for navigating the treacherous political waters that lie ahead.

Acknowledge the Economic and Policy Risks of Going Over the Cliff.

Tempting as it might be, the GOP should resist minimizing the very real and very likely negative consequences of going over the cliff. It is true that the risks are uncertain. Indeed, it is possible that, despite predictions to the contrary, the U.S. economy would continue to grow modestly, even with $500 billion in immediate tax hikes and spending cuts. And it is also possible that, despite massive cuts in U.S. military spending, there would be no real-world consequences in terms of degraded capacity to defend our interests worldwide.

But it would be highly irresponsible to assume that the effects of going over the cliff will be this benign. To the contrary, the best evidence indicates that imposing massive tax hikes and defense cuts in a very short period of time will both push the economy back into recession and leave the nation unprepared for any number of national-security contingencies. The Congressional Budget Office (CBO) has predicted that going over the cliff will push the unemployment rate back above 9 percent, causing hundreds of thousands of currently employed workers to lose their jobs in 2013. It is not possible to overstate how destabilizing this would be, coming as it would just a few short years after the worst financial crisis in decades. The political fallout would be substantial. Meanwhile, going over the cliff would force the Defense Department to impose indiscriminate cuts at the very moment when international tensions are rising in the most dangerous corners of the world. No serious person thinks this is a good idea.

So House speaker John Boehner is absolutely right to lead the party in seeking a solution to the problem.

Remember that the White House Has Far More to Lose.

Nonetheless, having recognized the important reasons to steer clear of the fiscal cliff, the GOP shouldn’t be overly concerned about getting blamed for failure. Yes, it’s possible that public opinion will side more with the president if the talks break down. But there’s no way the president wants to risk pushing the U.S. economy back into a recession. Most Americans still think we haven’t recovered from the last one. Even a shallow second recession during his second term in office would be disastrous for President Obama. The spike in unemployment would become the story of 2013.

Some congressional Democrats are openly calling on their fellow partisans to take a no-compromise line in negotiations with the GOP because it’s the GOP that has the most to lose in the talks. That’s almost certainly wrong. If there’s no deal, and economic turmoil ensues, the president’s second term will be irrevocably damaged.

Be Practical and Strategic on Taxes.

The president just won reelection, and the Democrats picked up seats in the House and Senate. They are going to insist on a tax hike on the rich, even in the very short term, just to avert the fiscal cliff in January. Speaker Boehner has already acknowledged this as a fact of life, and he was right to do so. There’s no sense in denying political reality. The question is how to impose some sort of tax hike on the very wealthy without doing damage to the long-term goal of a simpler, more pro-growth tax code. There’s no magic formula for doing this, but the ideas now being floated — such as a new limit on the available deductions, credits, and exemptions for very high-income households — are exactly the right place to start.

It’s certainly true that striking a deal with the president on this issue in the next month will create some division within the GOP. There’s no avoiding that at this point. But there’s also no reason that this kind of a deal, if handled correctly, should do any long-term damage to the party’s brand. The GOP is clearly committed to keeping taxes as low as possible for all taxpayers. That was evident in the 2012 campaign, and that’s the party position even in these negotiations. The fact that the president is insisting on imposing a tax hike to avoid economic calamity shouldn’t be held against Republicans who are working to minimize the damage.

The GOP can also help itself by seizing the opportunity to push for an extension of payroll tax relief for working Americans, as Ross Douthat argued in the New York Times. The single largest item in the fiscal cliff is the pending expiration of a two-percentage-point cut in the payroll tax, worth about $100 billion annually. This tax cut lowered the Social Security payroll tax from about 12 to 10 percent on all earned income (up to a limit of just over $100,000 annually). In January, if the cut is not extended, all 155 million American workers will see this two-percentage-point hike in their taxes. The Obama administration is ready to let it expire because it fears a long-term cut might create pressure for additional Social Security reform — which is precisely why the GOP should support keeping payroll taxes, as well as income taxes, as low as possible.

Be Clear on Entitlement Reform.

The hardest part of these negotiations will be the battle over entitlement reform. The bottom line for the GOP should be this: There should be no deal on long-term taxes without far-reaching reforms to health-entitlement programs. And what’s far-reaching? For starters, the entirety of Obamacare should be on the table for revision and retrenchment. The law sets in motion the largest entitlement expansion in a generation. It’s far better to scale the program back now before it gets started than to wait and hope it can be scaled back later.

Republican governors have substantial leverage in these negotiations because they can opt out of the Medicaid expansion in Obamacare, thanks to the Supreme Court. If 25 or so Republican governors refuse to put more people into an unreformed Medicaid program, it will put tremendous pressure on the Obama administration, which is desperate to see the Medicaid expansion occur during the president’s second term.

The congressional GOP should use this leverage to move Medicaid toward fixed financing and maximum state flexibility.

In the end, serious entitlement reform will require moving the Medicare program toward a competitive structure. The GOP has embraced this concept, and there’s absolutely no reason to back off now (the election’s outcome was due to other factors, not “Mediscare” tactics by Democrats). No doubt the president will insist on more government-imposed cost controls instead of a genuine consumer-driven approach, even though cost controls would be disastrous for American health care. This could easily be the issue on which the talks founder, but it is absolutely essential that the GOP not fall in line with the Democrats’ long march toward full government control of the health system.

One last point: The GOP shouldn’t be in a hurry to wrap up a deal in December. The party should spend this month finding a formula for averting the January 1 fiscal cliff, and hold off most of the serious negotiations over tax and entitlement reform until 2013. That timing will probably be far more favorable to the GOP than a deal that is struck less than two months after the president’s reelection.

— James C. Capretta is a fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute.


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