The deal also will renew the federal estate tax (which Republicans have referred to as the â€œdeath taxâ€). The tax only applies to the portion of an inheritance above $5 million for individuals or $10 million for couples. The tax rate on the portions of the inheritance above the $5 million or $10 million exemptions will be 35%. The estate tax has varied in recent years. In 2009, the last year the federal estate tax was in effect, the first $3.5 million of the inheritance was exempt. At the insistence of the White House, the compromise also extends several tax credits aimed at working class families that were first included in last yearâ€™s economic stimulus bill.
The compromise also provides continuity for two years for the top 15% tax rate on capital gains which was due to expire at the end of the year, and a fix to prevent the Alternate Minimum Tax (AMT) from hitting 21 million middle class households next year.
Despite the concern expressed by both Democrats and Republicans over the size of the federal budget deficit, there are no budget offsets to cover the estimated $900 billion cost of the compromise package over the next two years. All of it will be added to the national debt.
OBAMA ADMITS DEFEAT
In brief remarks Monday evening announcing the compromise, Obama said while he still didnâ€™t like the extension of the tax breaks for those in the top income brackets.â€œEver since I started running for this office, Iâ€™ve said that we should only extend the tax cuts for the middle class.â€ But he then said that giving in to the Republican demand was better than allowing all of the Bush tax cuts to expire at the end of this year.
â€œItâ€™s not perfect, but this compromise is an essential step on the road to recovery. It will stop middle-class taxes from going up. It will spur our private sector to create millions of new jobs, and add momentum that our economy badly needs,â€ Obama said.
He then made a plea to liberal Democrats to back the compromise, despite their principled objections to its provisions. He said that, “sympathetic as I am to those who would prefer a fight to compromise, it would be the wrong thing to do. . . The American people didn’t send us here to wage symbolic battles.”
However, most liberal Democrats in both the House and Senate were furious at Obama for caving in to the Republican demands for continuing the high income bracket tax cuts and cutting the estate tax.
OBAMA UNDER ATTACK BY DEMOCRATS
The explosion of anger at the compromise from his own party forced Obama to come out before the White House press corps Tuesday to defend his decision to accept the compromise. He argued that he had no alternative but to accept the compromise in order to avoid an across the board tax increase on all Americans at the start of the year and the expiration of unemployment benefits for workers who have already been jobless for two years. However, he promised to renew his fight against Republican tax policies over the next two years.
Justifying his decision as necessary to protect the national interest, Obama declared â€œIâ€™m not here to play games with the American people or the health of our economy. My job is to do whatever I can to get this economy moving. My job is to do whatever I can to spur job creation. My job is to look out for middle-class families who are struggling right now to get by, and Americans who are out of work through no fault of their own.â€
CONDEMNING REPUBLICANS AS â€œHOSTAGE TAKERSâ€
Using harsh, class-warfare language, Obama portrayed the Republicans as determined to defend tax breaks for the rich. In a provocative statement, the president who campaigned for office on a promise to bring the country together, accused the Republicans of holding the American people â€œhostage,â€ because they refused to buckle to Obamaâ€™s insistence on a tax increase, as of January 1 for upper income taxpayers. He also said that although it was tempting to refuse to give in to the â€œhostage takers,â€ (meaning Republicans) he could not do so if that meant that the â€œhostagesâ€ would be harmed, turning them into â€œcollateral damageâ€ in what was essentially a political fight.
He emphasized that he had to act to break the political deadlock because he was confronted with a hard deadline, the expiration of all the Bush tax cuts and extended unemployment benefits on January 1st.
At the end of the news conference when a reporter suggested tht by compromising with the Republicans he was sacrificing his political principles, Obama responded with a flash of anger, saying, â€œTake a tally, look at what I promised during the campaign. Thereâ€™s not a single thing that I have said that I would do that I have not done or tried to do. And if I havenâ€™t gotten it done yet, Iâ€™m still trying.â€
THE WRONG WAY TO COMPROMISE
Democrat presidents have successfully cut compromises with congressional Republicans before. Bill Clinton used the tactic to reclaim the political initiative after the historic 1994 GOP midterm victory, and he did it with a smile. But while Clinton celebrated his â€œtriangulationâ€ compromises as political victories, Obamaâ€™s compromises telegraph his sense of frustration and defeat. This only accentuates his political weakness, while frustrating and angering his liberal base.
In response to the criticism from liberals, the White House argued that the 2% cut in the payroll tax will provide more benefits to working class Americans than to those in the higher tax brackets. But most liberal Democrats were too angry to listen. Some seemed stunned at their dramatic reversal of political fortunes, and that Clinton gave up the tax cut initiative even before the newly elected Republican Congress was seated. Others talked about the unlikely possibility of mounting an effort to deny Obama the 2012 Democrat presidential nomination.
Congressman Anthony Weiner faulted Obama for failing to put up a proper fight for the liberal position before caving in to GOP pressure and agreeing to the compromise. Democrat analyst Paul Beglala was also critical of Obamaâ€™s message telling liberals who oppose the compromise as a matter of principle that voting against it in the House and Senate would â€œbe the wrong thing to do.â€
Shortly after Obama announced the compromise, there were statements by some Democrat congressional leaders that the White House did not necessarily speak for them. Chris Van Hollen of Maryland said, â€œThe House Democrats have not signed off on any deal. We will thoroughly review and discuss the proposed package in the caucus.â€
The liberal revolt among the Democrats against the White House deal quickly grew. Even the partyâ€™s leaders in the House and Senate, House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid were careful to remain publicly neutral on the compromise while trying to gauge the depth of the rebellion in their ranks.
As Obama was speaking at his press conference, Vice President Joe Biden was meeting at the Capitol with Reid and other Senate Democrat in order to bolster support for the compromise package. Emerging from that meeting, Reid said, “It’s something that’s not done yet. We’re going to have to do some more work.”
On the House side of the Capitol, Pelosi issued a statement that said merely, “We will continue discussions with the president and our caucus in the days ahead.”
The most extreme comments came from Senator Bernard Sanders, of Vermont, who is technically an Independent and widely considered to be the most liberal member of the Senate. He called the compromise â€œmoral outrageâ€ and threatened to lead a filibuster in the Senate to block its passage. He said in an interview, “I’ve got to tell you, I will do whatever I can to see that 60 votes are not acquired to pass this piece of legislation.”
Sanders also argued that instead of giving in to the Republican demands, Obama should have led his party in a concerted effort to win over the additional Republican Senate votes needed to pass the Democrat tax cut and unemployment benefits extension.
Senator Richard Durbin (D-Ill.), who is the number two Democrat in the Senate, warned in an interview after the compromise was announced Monday night that, “There is a group [of Democrats] that may walk. Let’s say at some point, ‘You’ve gone too far.’ “
Senior congressman John Conyers (D-Mich.) also pledged to try to stop the compromise from passing in the lame duck session of Congress. “This is a fight for the heart and soul of the Democratic Party and the nation,” Conyers said. “I can tell you with certainty that legislative blackmail of this kind by the Republicans will be vehemently opposed by many if not most Democrats, progressives, and some Republicans who are concerned with the country’s financial budget.”
A MAJOR GOP VICTORY ON TAXES
Republican leaders, on the other hand, were quietly pleased that the full Bush tax cut package will survive for at least another two years, as well as a significant reduction in the estate tax. They are convinced that the tax cuts will encourage small business owners to do more hiring, and that it will be a more effective economic stimulus than more government spending. As a matter of principle, they believe that raising taxes on any group of Americans is a particularly bad idea at this time and would damage the recovery. They believe that the source of the economyâ€™s problem is too much government spending, and that cutting taxes as called for by supply side economics, is the best way to bosst economic growth.
One of the factors which drove the compromise was the realization that the current economic recovery remains extremely fragile and uneven. This was demonstrated by disappointing nationwide unemployment numbers for November released last week, driving the official national jobless rate up to 9.8%.
There is a growing gap between surging business activity, reflected by encouraging results being reported by retailers in this shopping season, even as the housing market remains in the doldrums, and local and state governments, which wrestle with huge deficits, forcing them to lay off employees.
Emblematic of the problem was the announcement by New York City Mayor Michael Bloomberg last week that the cityâ€™s workforce will be cut by more than 10,000 over the next year-and-a-half, to help close a $3.3 billion deficit in next year’s budget. That will necessitate the firing of more than 6,200 current city workers, with the remainder of the cuts achieved through attrition.
At the same time, about 2 million long-term unemployed workers will run out of their extended jobless benefits this month if they are not renewed by Congress. It is estimated that 7 million people will ultimately be affected by the 13 month extension of the extended unemployment benefits.
The November jobs report also showed that the number of Americans who have been unemployed for 27 weeks or more remains at record high levels, and represents more than 40% of all people who are out of work.
NORMAL UNEMPLOYMENT LEVELS NOT LIKELY TO RETURN SOON
The main problem is that the pace of the recovery slowed by half from the end of last year to just 2.5% for the 3rd quarter of 2010. At the same time, the larger profits being generated by businesses have not led to the re-hiring of the 8 million workers laid off since the start of the recession.
Instead, US businesses are using the productivity gains they have realized in recent years to generate more sales with fewer employees. Business leaders cite the continued cost pressures they are under from competitors in the global market, as well as uncertainties over the additional costs that they will have due to health care reform, new taxes and other policies that the Obama administration wants to introduce.
As a result of these pressures, economic experts, including Federal Reserve Chairman Ben Bernanke are predicting very slow job growth which will result in the unemployment rate remaining at around 10% for at least the next year or two.
In an interview Sunday, Bernanke said that it could take four or five more years for unemployment to fall to the pre-recession levels of 5 to 6 percent that the country had come to regard as normal. He said the weakness of the recovery required the Fed to continue its stimulative policies, such as its plan to purchase $600 billion in US Treasury securities, in order to counteract the danger of a double dip recession. He didnâ€™t use that phrase in the interview, but did admit that the recovery is now so weak that it might not be self-sustaining, which amounts to the same thing.
DEMOCRATS STUCK WHILE REPUBLICANS ARE READY TO DEAL
Given the fragile state of the economy, Bernanke argued that Congress shouldn’t cut spending or boost taxes for anyone, implicitly endorsing the subsequent deal which will, if passed, extend all the Bush tax cuts, for the next two years, along with an extension of long-term unemployment benefits.
Democrats in Congress are still obsessed with making the losing argument that a vote to extend all of the Bush tax cuts would unfairly benefit high income taxpayers, a concept that was soundly rejected by the voters at the polls last month.
Republicans argue that what the Democrats are proposing is, in fact, a tax hike on just the wrong segment of the population. It is the people in the upper income tax brackets who own the small businesses and who make the investments that are so essential to speed the growth of the economy and generate the new jobs that are so desperately needed.
The Republicans are confident that the same â€œsupply side economics,â€ based upon tax cuts for everyone, that restored American prosperity during the Reagan administration to restore prosperity.
In the process, Senate Republicans gave in on extending long term unemployment benefits, and dropped their insistence that the extension of jobless benefits be paid for by cuts elsewhere in the federal budget.
The Republican attitude was expressed over the weekend by Senator Orrin Hatch, R-Utah, who said, “Let’s take care of the unemployment compensation even if it isn’t … backed up by real finances. We’ve got to do it. So let’s do it. But that ought to be it [in terms of unfunded new spending measures].”
FED NOW WORRIED ABOUT THE RISK OF DEFLATION
Bernankeâ€™s worries about the durability of the recovery was the main reason why the Fed is now embarking on a second round of Treasury bond purchases, known in financial circles as â€œquantitative easing,â€ or QE2. The Fed chairman fears a scenario in which weakened consumer demand due to continued high unemployment leads to deflation, with a downward spiral of wages and prices driving a double dip recession. Bernanke hopes that QE2 will help to keep interest rates low and give investors an incentive to buy more stocks, supporting prices and bolstering demand.
Since the Fed announced the QE2 policy on November 3, US trading partners have complained that it amounts to a deliberate attempt to devalue the US dollar on international currency markets. Domestically, critics of the policy claim that it â€œmonetizesâ€ the deficit by printing new money with nothing to back it, which could eventually ignite a new round of inflation.
Bernanke disagrees, arguing that the greatest danger to the US economy is the threat of deflation. He also promises to monitor the reaction of the economy to the QE2 stimulus and to cut it off at the first signs that inflation is getting out of control.
Surprisingly, in the month since Bernanke announced QE2, the value of the US dollar on international currency markets has increased instead of declining, largely due to renewed fears over the spread of the European debt crisis and the resulting decline in the value of the euro.
Other economists agree with Bernanke that despite trillions of dollars in new capital which the Fed has injected into the financial system over the past two years, small businesses and consumers are still having trouble gaining access to the credit they need. As a result, the small businesses which historically have generated most of the new jobs in this country are still being starved of operating capital.
BERNANKE OUT TRYING TO â€œSELLâ€ HIS POLICIES
Bernanke has waged an aggressive public-relations campaign in defense of the QE2 stimulus. This is a sharp departure from the behavior of the previous Fed chairmen, Alan Greenspan, who limited his public appearances to required testimony before Congress and occasional addresses to major banking and economic groups. Greenspan also deliberately couched his statements in dense, vague language.
By contrast, Bernankeâ€™s interview sounded very much like a politician trying to â€œsellâ€ a controversial set of economic policies to a skeptical American public.
Bernankeâ€™s critics say that his high profile public appearances are damaging the Fedâ€™s once carefully guarded image of strict independence from partisan political influence.
WHY THIS RECOVERY IS DIFFERENT
Bernanke also expressed his concern over the social effects of so many workers remaining unemployed for so long. Previous recoveries quickly put people back to work because manufacturing-based businesses needed more employees to satisfy increased demand. However, because so much US production has now been outsourced to foreign countries, the quick rehiring of idle US workers that used to come with recoveries is no longer automatic. Todayâ€™s more service-based US businesses can often add capacity more efficiently through investments in new technology rather than by adding more workers.
That means many of the US jobs which were lost during the most recent recession will never be coming back, at least in their original form. To replace those jobs, the US economy will have to create new kinds of jobs for which many of these unemployed workers may not be suitable.
THE EFFECTS OF LONG TERM UNEMPLOYMENT
Bernanke worries that long-term unemployment could create a permanent division in this country. “It’s a very bad development,â€ he said. â€œIt’s creating two societies. People who are unemployed for such a long time … their skills erode. Their attachment to the labor force diminishes and it may be a very, very long time before they find themselves back in a normal working position.”
The unemployment rate is also the barometer with which most voters measure the overall health of the economy. Democrats are painfully aware that unless they can bring the unemployment rate down within 18 months, they are likely to face another disaster at the polls in 2012, losing both the White House and the Senate to the Republicans.
Obamaâ€™s deal with congressional Republicans was prompted by the mutual recognition that the recovery is now so fragile that allowing the Bush tax cuts to expire at the end of this year, even briefly, could tip the economy back into a recession, something for which neither side wanted to risk being blamed.
THE NEXT DEBATE: CUTTING THE DEFICIT
The compromise between Obama and congressional Republicans were all about short-term tax and spending issues, but the longer term economic policy debate that will dominate Washington over the next two years is waiting in the wings. Last week, a bipartisan presidential commission studying ways to bring budget deficits under control failed to reach a consensus on a specific plan of action, but it did identify the main available options for cutting the projected $4 trillion deficit projected for federal budgets over the next decade.
None of the proposed spending cuts, tax increases and entitlement cutbacks on the commissionâ€™s list is politically palatable. But the growing public concern over the ballooning deficit helped to elect many Republicans in last monthâ€™s midterm election by running on a platform promising to reduce the size of government by making the necessary, tough, cost cutting decisions. One such courageous decision was recently made by New Jersey GOP Governor Chris Christie, when he cancelled a badly over-budget rail tunnel to connect New Jersey and Manhattan because New Jersey simply could not afford to pay its share.
By contrast, despite his decision to compromise with Republicans over the Bush tax cuts, President Obama seems determined to keep pushing his liberal, big government agenda. The challenge facing Republicans coming to Washington next month will be developing a viable and more fiscally responsible alternative to Obamaâ€™s policies to lay before the voters for the 2012 campaign. Economics has long been known as the â€œdismal science,â€ but if the Republicans can succeed in this task, they can save the country as it sits on a precipice.