Nov. 9 (Bloomberg) -- The last time President Barack Obama and House Speaker John Boehner squared off over fiscal problems, they triggered tremendous market volatility, cost the U.S. its AAA credit rating and nearly pushed the government into default.
Voters were so impressed with the results that they have re-elected the two leaders so they can have another go -- this time to help the country avoid a headlong dive over the dreaded fiscal cliff.
Fear not: The players are the same, but the game has fundamentally changed.
The battle in 2011 over the debt ceiling wasn’t actually about the debt ceiling: It was about fixing the deficit. But neither side wanted to accept a compromise that might antagonize party loyalists on the eve of campaign season or to make concessions that the election outcome might render unnecessary.
They spent so much time debating an unreachable big deal that they had to rush simply to agree to raise the debt limit without defaulting. Markets shudder when the country with the lowest credit risk in the world has to think about paying its bills.
The fiscal cliff -- the automatic tax increases and spending cuts set to take effect in January if Obama and Boehner don’t reach a budget deal -- is much different.
There is a large battle to be had over broader deficit reduction, but that is not the immediate issue facing Washington on Jan. 1. No one thinks the deficit will be solved in the lame-duck period: Avoiding the fiscal cliff means simply finding a way to delay the problem this year without surrendering negotiating leverage for the larger fight next year.
In 2011, expectations were raised that Democrats and Republicans would solve fiscal problems in conjunction with a debt-limit increase in order to avoid a credit downgrade and keep the bond vigilantes at bay. This year, credit raters and Treasury markets have signaled that the U.S. will not be punished for “punting” decisions into 2013.
Thus, avoiding the fiscal cliff requires only “building a bridge” to the new year. Both sides have clear incentives to avoid a disaster for which both parties would be blamed. Neither side has a better alternative. That’s why the fiscal cliff is a self-denying prophecy: It’s so bad, it not only can’t happen, it can’t credibly be threatened.
If either side takes a hard-line position while threatening to push the U.S. over the edge, external pressure from business leaders and voters rains down upon it. That’s why neither side campaigned on willingness to go over the cliff absent a deal on its terms.
Obama was just re-elected on a pledge to raise taxes on the wealthiest Americans, and voters have given him a mandate to pursue his policies. Some of the fear aroused by dire media warnings of fiscal-cliff disaster centers on the misconception that, because the so-called Bush tax cuts expire at year-end, the president has an incentive to ride over the cliff, let all these tax cuts expire, and then simply put the tax cuts for the middle class back in place next year.
Of course, in the interim, there would be a dramatic fiscal and market shock from both the onset of austerity and the fear that it will not be reversed.
If there is no fiscal cliff deal, Obama would then preside over economic and financial carnage as he tries to frame his second term. Instead of crafting an ambitious second-term vision for his January inaugural address, he would instead spend his time and energy trying to push off blame for the economic calamity under way.
The voters who just granted him a second term would see hundreds of dollars of cuts to their first paychecks in 2013. Companies that backed him will fire workers as government contracts are cut and the broader corporate community will scream about how the recovery has been knocked off course. Far from freeing him to play hero later, this meltdown would strangle his second term before it began.
Boehner’s position is similar. The election’s weakening of the Tea Party strengthens the speaker’s control of his caucus, but he is weaker today relative to the newly re-elected president than he was last year. Boehner knows he risks a public backlash if he appears to lead a party blamed for legislative obstruction into plunging the U.S. economy over the edge.
That sort of blame would dramatically reduce his leverage in the larger 2013 fiscal debate where the real, substantive issues remain on the table. This came through very clearly in his first post-election press conference: In total contrast to the shoot-from-the hip speaker of 2011, Boehner’s speech was a plea for a deal, delivered from two teleprompters. He knows he has little room for error.
Both men want to avoid disaster before the year’s end and earn some credit for a landmark deal in 2013. The only way to do that is to avoid the immediate cliff by building a bridge.
This will require a president who will never again face the judgment of voters to move off his pledge to veto across-the-board tax cuts at year’s end. It will require Republicans to provide Obama political cover to do so by agreeing to some smaller down payment now -- such as reducing the amount of tax deductions the wealthy can take in 2013. It will then require around-the-clock negotiations to decide how to word such a deal and to twist enough arms to make sure it can pass Congress before the turn of the year.
Will Washington do all this before the New Year’s Eve ball drops in Times Square? Given the pain that failure would inflict on everyone involved, both sides have little choice.
(Sean West is U.S. practice head and director at Eurasia Group, a global political risk advisory firm. You can follow him on Twitter at @seanpwest. The opinions expressed are his own.)
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