The fiscal cliff is more of a cascade -- or a game of dominoes. First, they have to make a deal on the terms on which the Bush tax cuts will be renewed. That appears to be fairly likely, since GOP leaders seem to have conceded that additional revenues are inevitable. So, the deal to be struck is how precisely to raise another $800 billion over ten years from higher-income households. John Boehner can probably get his caucus to agree, so long as it does not involve a new, 39 percent tax rate. And the only way to raise $800 billion without hiking the top rate is to raise instead the tax rate on capital gains, dividends and interest. So, look for a 25 percent rate on capital income for the top two percent -- a change that will hit the very wealthy more than well-paid professionals.
If they can manage to compromise on high-end tax increases, they get to move on to the next stage: Some broad understanding of how much can be cut from defense, other domestic programs, and entitlements over the next ten years -- and perhaps, how much additional revenues can be raised from business. As Republicans will have to concede more substantively on high-end tax increases, the administration will have to concede more here, especially on entitlements and almost certainly on business tax increases too. Any kind of broad agreement should be enough to let them delay the automatic across-the-board cuts in defense and non-defense spending now scheduled for Jan. 1.
And if they can manage to compromise on the broad terms of a big budget deal, they get to move to stage three -- actually negotiating what to cut and by how much. As Republicans are effectively going to dictate the terms of the tax increases on higher-income people which they've been fighting -- i.e., no new 39 percent rate -- the Democrats will get to dictate the terms of the cuts in Medicare and Medicaid which they've been resisting. In the end, all of the changes will probably add up to less than is talked about today -- perhaps $3 trillion over 10 years rather than $4 trillion, and that almost certainly will include the $1 trillion in cuts agreed to in the last debt-ceiling fight as well as the $800 billion in new revenues. But it will be enough to get sufficient GOP support to raise the debt ceiling in April, and the economic expansion will be able to continue on its course.