With a newly-emboldened President Obama unwilling to let the mildly-chastened Republicans push him around any more, the news coming out of Washington is getting scary, and the $600 billion fiscal cliff—a combination of cuts in federal spending and elimination of tax breaks—that will push the US into a recession looks increasingly probable next month. Both sides began from where they’d left off before the elections. President Obama largely repeated his earlier $1.6 trillion proposal to tax the rich and raising dividend/capital-gains/inheritance taxes ($960 billion) and cut tax loopholes ($600 billion) while the Republicans began with a call to cut $2.2 trillion of entitlements (primarily in Medicare and Social Security). While the Republicans have climbed down a little and are now offering revenue increases of $800 billion through reductions of tax loopholes, they’re sticking to their Tea Party stance of never raising taxes. Understandably, an Obama who was pushed into a corner by the Republicans through much of his first tenure—and even had to suffer the ignominy of a debt ceiling crisis and even an S&P downgrade—feels he’s had enough. And while, given his sweeping victory, he may be right in thinking the electorate will blame the Republicans for the fiscal cliff, he could be gambling with the US economy, indeed the global economy.
Apart from the fact that raising taxes in a slowing economy is not always a sure thing, the evidence on hand should give Obama pause. As of December 3, according to Reuters BreakingViews, a total of 144 US firms have announced Q4 special dividends of $21.4 billion—some like retailing firm Costco are even borrowing money to pay the dividends—in order to take advantage of the current 15% dividend tax versus a possible 39.6% rate next year. Based on the dividends announced so far, assuming next year’s dividend tax goes up to 39.6%, that’s a potential annualised tax loss of over $20 billion next year just on account of the dividend jumping. BreakingViews’ columnist Daniel Indiviglio has an interesting take on the outline of a possible tax compromise. While raising taxes on American earning more than $200,000 would affect 2.4 million taxpayers, Indiviglio points out, raising this to $1 million will take 2.1 million taxpayers out of the net while reducing the potential tax collections by just a third. Surely that’s a compromise worth looking at? While the Republicans clearly need to rethink their strategy, especially in an America whose social structure is changing dramatically, President Obama would do well to show some flexibility as well. Falling off the fiscal cliff can’t be a great idea, even if voters think John Boehner pushed him.