Following his inauguration on Sunday, President Barack Obama begins his second term with a hostile House of Representatives controlled by his Republican opponents and a debt-ceiling crisis forcing him to bargain with Congress over tax rates and spending levels.
Mr. Obama and the congressional Republicans have been fighting this battle for a couple of years now. The latest signs suggest that they will avoid inflicting collateral damage to the U.S. economy such as was seen in the 2011 debt ceiling crisis. It is, however, far from clear that U.S. taxing and spending will be put on a sustainable footing in this presidential term.
When the U.S. government was about to go over the "fiscal cliff" of tax rises and dramatic spending cuts at the turn of the year, Senate Democrats worked out a compromise that House Republicans and the administration accepted. It avoided the severe stock market reaction that was anticipated when markets re-opened Jan. 2. The compromise raised to 39.6 per cent from 35 per cent the income tax rate for incomes exceeding $400,000 for individuals and $450,000 for couples. Republicans had promised no tax rate increases whatever and Mr. Obama had promised increased rates starting at the $200,000 and $250,000 levels. Markets, previously depressed by fear of an impasse, shot up.
Events unfolded very differently in the summer of 2011, when newly elected Republicans tried to enforce their views by refusing to grant a rise in the debt ceiling. Standard and Poors lowered the rating of U.S. government bonds and the Dow Jones Industrial Average dropped about 2,000 points in the first days of August before congressional Republicans bowed before the storm and let the debt ceiling rise.
The U.S. has now hit the debt ceiling again and something must be done. Republicans have been telling reporters they are willing to grant a three-month rise in the debt ceiling, deferring the showdown to March. Markets this week seemed to take this as a sign the negotiation would be more orderly this time and would not raise doubt about the credit-worthiness of the United States.
The underlying problem is that the U.S. government spends a great deal more every year than it collects in taxes and the gap is likely to widen every year because of increasing costs of old-age pensions, health care for the elderly and other programs that are written into law and not subject to annual budgeting decisions. The elements of this problem have been thoroughly described, but Mr. Obama has not succeeded in assembling majority support for a solution.
The large solution has to bring the spending down and the taxes up over a period of years until they will be in balance most of the time -- not just in years of rapid economic growth but over the whole of a business cycle of economic ups and downs.
The small successes that were achieved lately could be the confidence-building measures that would pave the way toward a larger solution. Republicans have now agreed to tax increases they swore they would never accept. Mr. Obama has granted a tax break to income earners in the $300,000 bracket that he had promised to tax more heavily. The country seems to have accepted this small solution to one small aspect of the large problem. Everyone involved and the watching world must be pleased that savings and investments are not being imperiled by politically driven market turmoil.
Members of the new Congress are now preparing for the mid-term elections in the fall of 2014. The U.S. political system and its campaign finance laws heavily favour incumbents, allowing them to raise vast sums of money from wealthy backers. Many of those wealthy backers probably favour low taxes, but after the nasty scare of the 2011 debt ceiling crisis, they may be urging their public officials to play nice -- argue for lower taxes through the regular democratic means but don't put the country at risk to get there.