Obama’s Big Challenge: How to Handle the Fiscal Cliff

Depending on which talking head you happen to be listening to, the fiscal cliff is anything from an absolute economic catastrophe to a mild bump in the road.  My guess is that it is more likely to have limited immediate consequences and that any long term effect would be lost to the myriad of other events that make assigning responsibility for almost any economic news hard to pinpoint.

But circumspect though I may be on the impact of the cliff (by which I mean going over it, of course), I’m not at all uncertain about the challenge it poses for Barack Obama as he looks to start his second term as the nation’s president.  In fact, I think how he handles this one might well define how successful his presidency will end up being, at least in terms of his domestic accomplishments.

The cliff (my shorthand) is the self-imposed set of economic events, all part of the Budget Control Act of 2011, which will take place starting on January 1, if Congress and the President do not theretofore agree to a debt reduction plan.  If we go over the cliff, the Bush tax cuts will automatically expire for all Americans, the Defense budget will be cut severely, and domestic spending will be cut significantly.

Republicans hate the cliff, primarily because of what it would do to the defense budget (and the defense industry that supports it).  Democrats don’t like it all that much either, mainly because of what it does to tax rates for the middle class and to the programs that are so important to the bulk of their constituents.

So, the easy prediction is that the cliff will be avoided because no one wants its impact to be felt.

But, of course, that is not entirely true, because, as with most things that happen in the nation’s capital, the politics of a resolution are dicey.  And that’s where Obama’s handling of the potential crisis and a deal that would avert such a crisis comes into focus.

The controlling wisdom is that the Democrats and Obama are in the driver’s seat, since they can let the Bush tax cuts expire and then fashion a new set of tax cuts that leave out the top two percent.  This strategy would put the Republicans in the awkward position of being against a tax cut, should they oppose the cuts because it leaves out the top earners.

But that thinking ignores what the Republicans might do to offset the political advantage the Democrats would seek.  Remember, the Republicans still control the House of Representatives.  There, they could just as easily move a competing tax cut bill, one which would restore all the Bush cuts.  Then it would be a media war over which party’s tax cut bill was better for the economy.

Of course, the President would argue that that issue was resolved by his re-election, since his main domestic policy point was to eliminate the Bush tax cuts for the upper two percent.

But the Republicans are nothing if not persistent, and the guess here is that they would find a way to make their tax bill sound more economically viable than the Democrats.  So hold your bets on the Democrats’ chances of prevailing on that battle, should it come.

And let’s remember that Obama wasn’t very good at carrying a national debate with the Republicans in his first term.  Partly this deficiency in his leadership was due to a naïve desire to “work with” the opposition.  In the first two years of his first term, he often ended up negotiating with himself, as he gave in to Republican demands, only to find that they weren’t meeting him halfway.  The watered down health care and financial reform bills were examples of how this strategy worked for the GOP.  Both bills ended up being far less radical than they otherwise might have been, largely because Obama didn’t appreciate how steadfast the Republicans were going to be in their opposition.

But the other problem Obama could face is one that only a president ultimately has to deal with, and that is that the economy is, finally, his responsibility.  He can play politics only to the point of risking a return to the recession he spent much of his first term getting the country out of.  In the end, just as was the case with the Republicans refusal to raise the debt limit in 2011, it is the president who has to make sure the ship stays afloat, and that means he has to give in if the other side is holding the country’s economy hostage.

Now, it can be assumed that Obama has learned his lessons.  And he is just coming off a big electoral victory that essentially repudiated much of the Republican’s bluster.  I would certainly expect that any deal he strikes will include a debt ceiling provision that removes that blackmail chip from the Republicans’ arsenal.

But anyone who thinks he has the Republicans over a barrel this month as the countdown to the cliff progresses is listening to the wrong pundits.  The Republicans are sweating, to be sure, but it’s Obama who is, or should be, losing sleep, because if the cliff arrives, and especially if it extends into the new year to the point that a relapse to recession becomes plausible, it will be Obama who will be holding the losing hand.

So, here’s how it shakes out:  Obama will hold out on the tax cuts for the wealthy until maybe the week between Christmas and New Year’s.  If he can get a deal struck with Boehner and the House Republicans, well and good.  But if he can’t, look for him to finesse his way into an extension of the tax cuts for everyone in return for a guarantee that the debt ceiling won’t be an issue for the remainder of his term.

Then the parties will fight it out to a state of inertia for the next four years while the country survives on its own.