Squabbling all the way to cliff edge

It was early on Friday Australian time that things really started looking grim.

Republican and Democratic congressional leaders threw their hands in the air, and then they pointed fingers.

They had come to the conclusion that the nation was probably going over the fiscal cliff.

The President, Barack Obama, was aboard Air Force One nearing Washington DC – he had cut short his Christmas break in Hawaii – when the Democratic Senate Majority Leader, Harry Reid, rose to address the chamber.

"Come the first of this year, Americans will have less income than they have today." he warned. "If we go over the cliff, and it looks like that's where we're headed, the House of Representatives ... aren't here. I can't imagine their consciences."

A spokesman for John Boehner, who as the Speaker of the House of Representatives effectively leads the Republican Party, fired back a terse denial of responsibility.

"Senator Reid should talk less and legislate more," he said. "The house has already passed legislation to avoid the entire fiscal cliff. Senate Democrats have not."

That was not quite true, although Reid should take no comfort in that.

There is more than enough blame to go around in the mess over the fiscal cliff – enough for Reid and Boehner and for their troops in Congress. Enough too for the President.

Because of their failure, it is likely that some, if not all, of the measures collectively known as the fiscal cliff will kick in on January 1.

These include ending federal unemployment benefits to 2 million people, slashing defence and health spending, and increasing income taxes across the board.

Should the whole suite of measures kick in and remain in place, they would collectively gouge about $US600 billion ($578 billion) from this fragile economy, forcing it back into recession and costing millions of jobs.

So how did it come to this?

The fiscal cliff is not an economic crisis but a political one – a trip wire set in place by the very politicians now entangled in it.

The crisis began last year, when the Republicans in Congress, many of whom were swept to power in the Tea Party revolution of 2010, refused to raise what is known as the debt ceiling – the amount of money Congress would allow the government to collect to pay its bills.

The fiery new guard of the Republicans had two goals when they refused to raise the ceiling. On the one hand they wanted to obstruct all government legislation, in a push to damage Obama and help win back the White House this year.

And many wanted to shrink the size of government by starving it of funds – if nothing else, the Tea Party's rise has been a tax revolt.

The problem was that by refusing to raise the debt ceiling they were not cutting government spending, because the money had already been spent. Instead they were seeking to balance the books by simply refusing to pay America's bills.

The result was predictable, but nonetheless stunning. The major credit rating agencies last year downgraded the US's rating from AAA for the first time in history.

As S&P explained at the time: "More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policy-making and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

"Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilises the government's debt dynamics any time soon."

Congress was stung into action – or what has passed for action since it became divided in 2010, with Republicans holding the House of Representatives and Democrats (almost) holding the Senate.

As part of their campaign of obstruction. the Republicans also began using the filibuster relentlessly. This effectively meant that overnight and without debate, the US Senate became a chamber in which a party needed a 60 per cent majority to govern. The Democrats were hamstrung in both houses.

Unable to come up with a deal to curb the nation's spiralling debt and deficit, Congress instead kicked the can down the road. (The fiscal cliff has its own vocabulary, in which kicking the can is a key phrase.)

The Republicans agreed to raise the debt ceiling only if both sides accepted a set of debt and deficit reduction measures so savage and arbitrary they would force the parties to agree on more sophisticated measures before they kicked in on January 1.

This set of tax increases and spending cuts became known as the fiscal cliff – a term first used by Ben Bernanke, the chairman of the US Federal Reserve.

The package includes cuts to all government programs (see box) including defence, welfare and health. Congress would allow all of the Bush-era tax cuts (which were passed with a sunset clause) to expire, meaning all Americans would pay more income tax. And they included scrapping parts of Obama's stimulus package, such as a payroll tax holiday.

The Republicans agreed to the package because at the time they were confident they would beat Obama to the White House and take control of Congress, giving them the power to cut government as they saw fit. The Democrats agreed because they had little choice.

This was the status quo until Obama won re-election and hours later reopened negotiations. He won the White House after a campaign in which he promised to cut spending and increase taxes on the wealthiest, while the Democrats increased their slim Senate majority and won the popular vote (although they failed to win a majority in the House of Representatives), but the Republicans still refused to countenance any tax increases.

The talks stalled again. Obama at first proposed the measures he had campaigned on – preserving the tax cuts for those on incomes up to $250,000. Then he upped his offer to $400,000.

The Republicans refused to budge. Finally Boehner acted, moving to get his own caucus to agree to a $1 million threshold and the protection of defence spending.

This was posturing – neither the President nor the Senate Democrats would ever agree to such measures – but it would allow him to claim the Republicans had sought to act.

In the end all it did was damage Boehner's reputation, when he called off a vote on the measure after he found he lacked the votes for it even among Republicans.

This was the situation Obama faced when he landed in Washington on Thursday morning, four days out from going over the cliff.

Should Congress fail to act decisively by the January 1 deadline, the worst of the cliff measures could be quickly averted, for reasons of spurious party politics rather than good governance.

The new Congress sits for the first time on January 3, by which time all the tax cuts will have expired. The Democrats could then introduce a bill to cut taxes for the bottom 98 per cent of Americans – a measure that would have the same effect as a deal this week preventing the cuts from expiring in the first place.

But it would allow the Republican anti-tax hardliners to boast to their constituents that they had voted to cut taxes for 98 per cent rather than raise them for the top 2 per cent. It is a distinction without difference.

There are perceived advantages to Boehner and Obama in allowing the nation to fall off the cliff.

Obama will get his tax increase either way in the new term. And on January 3, Boehner faces re-election as speaker, a vote he is more likely to win should he not force through any tax increases.

After Obama returned to Washington late on Thursday morning, Boehner recalled the house to sit again on Sunday. The talks will no doubt go down to the wire – but even if an agreement was made, it is not clear it could pass in time.

Polls show the Republicans will wear most of the blame should the deadline pass without action, but there is frustration even among Democratic staffers at how distant Obama has been throughout the negotiations, just as he was through the equally bruising fight to get his healthcare laws passed.

The favourite Christmas film in Washington this year was Lincoln, the Spielberg movie about how the great president fought to steer the amendment that abolished slavery through a divided congress. Unhappy comparisons have been made with Obama.

Even if the worst of the crisis is averted, much damage will already have been done.

Businesses have been reporting for months that they have delayed hiring workers and investing in new infrastructure; markets have already dipped nervously, and it has been revealed to Americans that even after the ordeal of the election, Washington still remains unable to govern effectively.

What is in the fiscal cliff?

About $US1.2 trillion ($1.5 trillion) in federal spending cuts kick in (about $US110 billion a year for 10 years), divided equally between the Pentagon and other federal agencies. These cuts would be phased in over a decade.

Federal benefits expire for 2 million unemployed Americans.

According to the Tax Policy Centre, going off the cliff would affect 88 per cent of US taxpayers, with their taxes rising by an average of $US3500 a year, and taxes would jump $US2400 for families with incomes of $US50,000-$US75,000.

Spending cuts and tax rises estimated to reduce real GDP by 0.5per cent this year. Unemployment rate to rise to 9.1 per cent by the end of the year.

"The consequences of that would be felt by everybody," US Federal Reserve chairman Ben Bernanke has warned.

Because these changes are phased in, most economists believe a deal cut in January or February would limit the impact.

This story Squabbling all the way to cliff edge first appeared on The Sydney Morning Herald.