Duel with the Tea Party

The U.S. Budget negotiations are all about the future of America’s economic policy

For months, the “fiscal cliff” in the U.S. has been the dominant issue of the financial world. It’s feared that the massive revenue increases and program cuts agreed to by Republicans and Democrats last year may negate the progress made over the past few months and plunge the nation back into recession. Only a great budget compromise could avert this danger.

As the day of reckoning approaches, all indications are that the U.S. will plunge into the abyss. Unlike the failed summer of 2011 negotiations, this time a newly re-elected President Obama refuses to give in to the Republicans. He is knowingly playing with fire by insisting on tax increases for the wealthy, which most economists agree are necessary to achieve deficit reduction. Since those rates will automatically return to the Clinton-era rates on Jan. 1, 2013, Obama holds the better hand. Then Obama can propose lowering rates for the middle class, something the tax-hating Republicans cannot realistically oppose, thereby achieving what he set out to do in the first place.

Speaker of the House John Boehner is stuck in an untenable position: the right wing of the Republican Party loudly disapproves of every concession he makes – including the budget proposal of which he refuses to provide details. He is discovering that pressure from the Tea Party is even more painful than any jump off the fiscal cliff.

This scenario may not be so bad, many economists now say, because tax increases and program cuts could be delayed for many weeks. But more important than short-term economic impacts, the first tax increase in 20 years would mean Americans would finally begin again to finance their own expenditures and not rely on China for credit.

Conservatives are right in pointing out that the U.S. needs to do something about their most important social programs – fortunately less needs to be done about Medicare because Obama’s healthcare reform measures will result in savings – but particularly with respect to Social Security. However, these are long term subjects that need not be resolved within weeks. And the exorbitant outlays for defense will be reduced, in any case, as the war in Afghanistan winds down.

Obama may face his toughest political problem in the new year, when it will be necessary to once again raise the debt ceiling to avoid national default. Republicans see this as an opportunity to apply pressure for their radical budget proposals. But there are already many indications that Obama won’t give in as he did in 2011.

At least that’s the hope. Financial markets won’t be able to survive another brutal tug of war over debt and the budget. Most importantly, the U.S. will escape the Tea Party’s stranglehold on economic policy and anti-tax dogma. If Obama is successful in doing that, his second term will be right on track.