The United States is headed for an economic version of a Wall Street triple witching hour. In finance, a triple witching house comes along four times a year, when options contracts on stocks, options contracts on stock indexes, and futures contracts of those indexes all expire at the same time on the same day. Washingtons own version will unfold at midnight, December 31, 2012. That is the moment when, at once, all of George W. Bushs tax cuts expire, President Obamas payroll tax relief ends, and the grace period before $1.2 trillion in across-the-board cuts runs out. If the President, Congress and the two parties cannot finally agree on what to do about spending and revenues, their doing nothing will actually solve most of the U.S. deficit problem. But all of that austerity coming at once would also shut down the U.S. economy.
We actually face something close to a quadruple witching hour, because sometime in late-December or early-January, within days or weeks of everything else, the U.S. debt limit will run out again. The irony is that if the lame duck Congress and possibly a lame duck President cannot resolve these matters, the United States could face a technical sovereign debt default even as its political gridlock carves out a sustainable path for its government debt. Given how tortuously difficult it has been to resolve any one of these issues thus far, on even a temporary basis, the health of the American economy demands some new political thinking.
The range of scenarios for the post-election period is mind-boggling. For example, conservatives might be tempted to trade a multi-year extension of payroll tax relief for permanent status for all of the Bush tax cuts. A newly-reelected President Obama might consider agreeing if, say, the Republicans also would agree to find some new revenues from other sources and fold in a multi-year extension for the debt limit. (Good luck with that.) And if Romney wins the White House, congressional Democrats could call his bluff, let him enter office with a sinking economy, and then force him to negotiate with a Senate Democratic caucus able to block whatever a GOP House passes. Or, in what would pass for a rosy scenario here, everyone may be so exhausted from the years of political trench warfare that all sides agree to extend everything for several more months, so the new Congress and whoever is President can try to work it all out.
Whatever the election results, the debate over taxes and the budget will dominate our politics and government through at least the first half of 2013. In fact, that happens nearly every four years. Since Ronald Reagans first term, most Presidents have figured out that they can use their initial budget and tax initiatives to carry most of their agenda and that their sway with Congress will likely only erode with time. To be sure, this initial focus on budget and taxes made more sense when Washington still knew how to forge bipartisan compromises. The question today is, can any president get the current crop of Republicans to sign on to any plan that includes new taxes? And without that concession, could any president persuade congressional Democrats to reform Medicare and Social Security?
If taxes and entitlement remain off-the-table, there can be no grand bargain and no resolution. For the short-term, the United States instead will face auto-pilot austerity. More important, the patience of global investors with our stumbling political process could run out, which would mean rising long-term interest rates. If that happens, the U.S. expansion will end before it can generate any benefits at all for most Americans.
The next president needs a game changer, one that might entice each side to make painful concessions, say, in exchange for control over the impact of those concessions. As president, Bill Clinton could intuit the terms of such mutual concessions. We will have to settle for a new process or for putting an old one to new use.
For many years, certain aspects of taxation have been seen as too complex and esoteric for even the professional tax mavens at the Senate Finance and House Ways and Means committees. The taxation of mutual and stock life insurance companies is an example. So when Ronald Reagan raised corporate taxes, the tax writing committees parceled out several billions of dollars in new revenues to the life insurers and told them to figure out how to raise it in ways that would be least disruptive economically. Those were simpler times politically, to be sure, but the same model could be adapted to our current problem.
Lets assume that the lame duck gives the President and Congress a few more months to work out everything. Next January, the President and the leaders of both parties in both houses agree on how to broadly allocate another $4 trillion in budget savings over 10 years, under new rules. Say, for example, that $1 trillion would come from new revenues, $2 trillion from entitlement reforms, $200 billion from discretionary defense spending, $300 billion from additional discretionary non-defense programs, and the rest from interest savings.
By agreeing to $1 trillion in new revenues, Republicans get the right to design whatever reforms they deem best to achieve the target. Similarly, by agreeing to $2 trillion in entitlement savings, Democrats gain the right to fashion whatever Medicare and Social Security changes they deem best. Similarly, Republicans could allocate the additional defense cuts, and Democrats would parcel out the additional, discretionary non-defense cuts. And the looming threats from the expiration of everything, combined with the knowledge that each party would control the terms of the changes it fears most, might just be enough to get both sides to agree to the underlying allocation of pain.