Don't Believe the Grand-Bargain Hype

Ignore the headlines. John Boehner hasn't actually said anything about raising new revenue.


Just when you thought we were out, Congress pulls us back in. The grand bargain is back, maybe.

Let's set the scene. For idiosyncratic reasons dating back to World War I, the Treasury has a statutory limit on how much it can borrow -- the debt ceiling. Now, it's a bit redundant that Congress votes on taxes and spending and then votes again on whether it accepts the consequences its tax and spending decisions, but that's the system we have. Debt ceiling increases have traditionally been a time for grandstanding before acceding to fiscal and financial realities -- until 2011. That's when Tea Party Republicans pushed the party not to raise the debt ceiling, if at all, unless the deficit was cut in equal measure. In other words, they threatened to force the United States to default on some of its obligations unless they got the spending cuts they couldn't otherwise get.

Enter the grand bargain. The basic contours of this legislative white whale were simple enough: cuts for revenue. Democrats would sign off on Medicare and Social Security cuts if Republicans would sign off on increased tax revenue. There was just one problem. Republicans would not sign off on increased tax revenue. But wait -- didn't John Boehner offer Obama $800 billion of new revenue? Not really. As Matt Bai of the New York Times reported, most of this "new revenue" was of the mythical variety. Boehner wanted to cut tax rates and tax loopholes so the latter would pay for the former. The new revenue was supposed to come from the allegedly higher growth this kind of tax reform would unleash. In other words, the Laffer curve.

Fast forward to today. The old gang is back together again in Washington and so is the debt ceiling, which we'll probably hit some time in January. Boehner is once again saying he's open to "new revenue" -- if new revenue means lower taxes. Boehner still wants lower rates and a broader base, with any additional revenue coming as "a by-product of a growing economy." Of course, as Matthew Slaughter, the Associate Dean for Faculty at the Tuck School of Business at Dartmouth, told me, the empirical evidence for this is pretty sketchy in general, and, more specifically, nobody thinks we're on the wrong side of the Laffer curve now.

This looks like a replay of 2011, but it shouldn't be. The Bush tax cuts are set to expire in January, and if they do, revenue will go up $4 trillion or so. In theory, Republicans have every incentive to negotiate this time around -- and they still might! -- but, well, that doesn't mean they will. There's another incentive here -- the incentive to stay in office. House Republicans could easily decide it's better to stay on Grover Norquist's good side and get the chance to cudgel Democrats as tax-hikers than it is to cut a deal that genuinely raises any taxes. Then there's the ideological part of it. As Slaughter told me, there are House Republicans who think breaching the debt ceiling would be salutary, because they think doing so would put us on a better fiscal long-term fiscal path for our children and grandchildren, despite the immediate economic pain.

There's a big caveat here. There's one last incentive we haven't talked about -- the incentive to appear intransigent to try to strike a better deal. It's possible. But what happens if Obama calls their bluff? Not a grand bargain. There are plenty of permutations when it comes to the Bush tax cuts, sequestration, and the debt ceiling, and most of them probably involve some kind of can-kicking a la the last debt ceiling deal. But it might be harder to kick the can this time around due to the Bush tax cuts. House Republicans could very well say they will not raise the debt ceiling if Obama lets the Bush tax cuts for the rich expire. In other words, hold the economy hostage. For his part, Obama has promised to veto any bill that extends the high-end Bush tax cuts. And that is what we call an impasse. It's not unthinkable that this game of chicken could end with us getting the fiscal contraction from the fiscal cliff that nobody wants. That would send us into recession, but the bigger issue is what Obama would do about the debt ceiling. One option that got serious consideration last time is invoking the 14th amendment to unilaterally raise it -- either that or Tim Geithner could start minting some trillion dollar coins.

Would you like some bananas with that republic?