After much drama, both houses of Congress have agreed with the president on a short-term plan to deal with the fiscal cliff.
No party seems very happy with it. This general lack of enthusiasm might be a good sign, an indication that both sides were willing to give up something to arrive at a compromise that is good for the nation as a whole. Or it might be an indication that the deal really isnt very good from any perspective. Id say it is much more of the second than the first, at least if one looks beyond the immediate run.
Remember that the problem of the fiscal cliff was the harm that would have been caused to the economy by a sharp fiscal contraction the combination of higher taxes and reduced spending that would have occurred if no agreement had been reached. That contraction would have equaled 3.5 percent to 4 percent of gross domestic product.
Historical experience shows that an abrupt contraction of that magnitude would have tipped us back into a recession and raised unemployment. The depth and duration of such a recession and of the likely loss of jobs is a matter of some debate. However, Federal Reserve Chairman Ben Bernanke probably represented the views of most economists when he started to warn against it 11 months ago.
The ideal outcome from the point of view of Bernanke and other economists would have been continued deficit spending now coupled with fully credible actions to balance the budget once the economy was stronger. In the current political climate, that was highly unlikely.
Yet from this point of view, cutting the adjustment from 4 percent of GDP to only 2 percent is an accomplishment. Economic growth will be slower, as will improvement in employment, but it wont be as bad as it could have been. So one may conclude that this less-bad-than-it-might-have-been deal is a success.
Unfortunately, most of the public never understood that the objective here was to prevent a too-rapid reduction in the deficit.
The White House never articulated that clearly, many Republicans disagree with Bernanke and other economists view that this was even a problem, and the media did a terrible job of explaining it.
So many people understood that this was an emergency effort to reduce the deficit, rather than to limit its reduction. It is natural that many see the agreement so far as a failure.
Those who focus only on the deficit and who oppose any increases either in tax rates or tax revenues, mostly House Republicans, see the deal as a surrender by their side.
However, commentators who describe the deal as a delayed-action triumph by George W. Bush have a point. Barack Obama campaigned on a platform of returning marginal tax rates on those earning over $250,000 to the levels they had been at from 1994 through 2000. But he also pandered to everyone with income below that level with demagoguery about how the middle class really deserves tax cuts. He now has won the symbolic victory of getting the higher rates for those above $400,000. But the rates for everyone else, in theory temporary from 2001 through 2012, are now permanent.
That will come back to haunt us. As the presidents critics long have pointed out, raising rates on the upper-income earners is far too little to close the budget deficit, particularly over the long term. What he got in the deal is estimated to raise some $60 billion per year at a time when the deficit is about $1 trillion.
Yes, more money can be raised by closing loopholes and broadening the base. But the rates that applied to everyone in the late 1990s were probably the best balance we had enjoyed over the last half century. Indeed, four of the last five balanced budgets we had in the past 50 years came with those rates. And there was little sense that taxes were a crushing burden in those six years. The primary argument for the 2001 tax cuts was that four years of surpluses, however slight, pointed the way to the national debt being paid off in a decade. (For more detail on the politics of the 2001 tax bill, see The Price of Loyalty, Ron Suskinds account of Paul ONeills time as Treasury secretary under George W. Bush.)
The Simpson-Bowles report identifies spending equal to 20 percent of GDP as a desirable size for the federal government. Paul Ryans fiscal plan says about the same thing.
That is about how big it was during the Clinton years, and a bit smaller than it was in the Reagan era. Accept this argument and the one that the government should not run perennial budget deficits and you come to the conclusion that tax revenues should also equal about 20 percent of GDP.
They were nearly that level in the last four Clinton years, the ones with slight surpluses. But if you make the rates that came in with the Bush cuts permanent, as we just have, it becomes impossible to once again return to that level of revenue. So George W. Bush has finally seen his successor agree to what he himself strived for vainly.
The whole wrangle is far from over. The next round will be an increase in the national debt limit and hashing out the details of undoing the automatic sequestration that has been kicked a few weeks down the road. This will be just as messy as the past few weeks.
The most disappointing aspect of the deal is its continuing demonstration of the dysfunctionality of the U.S. political process.
Those who argue that uncertainty harms economic growth are correct. But the big uncertainty that dogs both households and businesses right now is not the exact tax rate people and businesses will pay.
It is rather whether our politics can produce elected officials who can come to agreement on key policies.