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Dangling Off The Fiscal Cliff

December 10, 2012
As the December 31, 2012 deadline approaches, both Democrats and Republicans are focused on producing a bipartisan agreement to avoid the fiscal cliff doomsday scenario. If a compromise is not reached, the automatic implementation of increased tax rates and across the board spending cuts could be a catalyst for a new recession. While a general consensus exists in Washington that a deal must be forged, the prospect of reaching a negotiated agreement remains an elusive task.

The current proposals by both parties represent different approaches to dealing with the fiscal cliff scenario. Republicans have focused their efforts on developing a plan that reduces the deficit through spending cuts and not tax increases, while Democrats favor a plan that produces more modest spending cuts while increasing revenue through tax raises on upper income earners.

The Obama Administration has proposed a plan to cut $4.4 trillion from the deficit over the next ten years. A key component of the Administration's deficit reduction strategy is allowing for the Bush era tax cuts for upper income earners to expire, while at the same time extending the tax cuts for all other taxpayers. The plan estimates that the tax increase on top-level earners will bring in $1.6 billion in revenues. Total cuts in entitlement programs including Medicare, Medicaid, other health care programs, farm subsidies, and agency budgets would result in savings of $600 billion. Also factored into the total calculations are $1 billion in cuts that have already taken place, $800 million in future savings from scaling down our overseas military operations, and $600 million in reduced debt service payments. Additionally, the Administration's proposal includes $200 billion in new spending for public works projects, unemployment benefits, and homeowner aid.

The GOP plan proposes to cut deficits by $2.2 trillion over the next decade. Unlike the Administration's plan, this proposal does not include prior cuts, future savings from military operations, nor reductions in debt payments which, if included, would create total savings of $4.6 trillion. The bulk of deficit reduction in the GOP plan, $1.4 trillion, stems from spending cuts to entitlement programs such as Medicare, Medicaid, Social Security, as well as from agency budgetary cuts. Taxes are also an integral aspect of the GOP proposal, but instead of growing revenues through tax rate increases, the plan seeks to raise $800 billion in new revenue through the elimination of tax loopholes and deductions. The GOP plan would also extend the Bush tax cuts for all taxpayers, including upper income earners. The Republican proposal does not include any new spending.

Neither the Democratic Party nor Congressional Republicans have signaled a willingness to concede their respective priorities to reach an agreement. A key point of contention has been the Obama Administration's aversion to accepting a plan which does not increase taxes on upper income earners, while at the same time Republican leadership has remained committed to  extending the Bush era tax cuts for all taxpayers.

Despite their reluctance to come to an agreement, there is still hope that the rapidly approaching fiscal cliff deadline will incentivize both parties to reach a compromise. Nevertheless, the closer we get to December 31, the more likely we are to face the harsh reality of  irreconcilable disagreement.

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