THE BLOG
03/08/2013 04:29 pm ET Updated May 08, 2013

The Sequester Battle Is Over -- Now It's All About Entitlements, Tax Reform and the Debt Ceiling

Obama got his tax rate increase for the top 1 percent in the fiscal cliff" resolution in January, and Speaker Boehner got his forced budget cuts with the sequester, and both have apparently silently agreed to finesse the end-March "continuing budget resolution'" without another "government shutdown" moment by simply living with the agreed budget for the balance of this fiscal year (including the sequester effects), with only a relatively minor skirmish about the president's authority to move cuts around the Pentagon.

It's an odd sort of standoff. The president is swallowing significant cuts to discretionary social programs as a cost of his insistence of closing tax loopholes as part of any deal; Boehner has given up securing significant cuts to entitlement growth offered by Obama in order to appease his anti-tax base and Wall Street hedge fund and private equity managers (the now-preserved "carried interest" privilege that gave Mitt Romney his 14 percent tax rate). With the sequester's $1.2 billion in cuts over 10 years now added to the previously agreed $2.5 billion in reductions in expenditures (including the war wind-downs and lower interest bills), we are now only $300 billion away from the $4 trillion in deficit reduction targeted by Simpson-Bowles -- and that's without counting the $600 billion tax increase that came with the fiscal cliff arrangement.

There is no way that the Republicans can now back out of their "pro-loophole" corner without being seen to capitulate to the president on the sequester, and the same for the president on his "anti-loophole" stance, so there can be no progress to a deal as long as we are talking about just the sequester, no matter how loudly those affected scream about the cuts. Long lines at airports, closed national parks, kids home from day care and reduced cancer research will not sway the Tea Party Republicans who "won" this round (although they lost on their effort to cut entitlements).

But if entitlements were to be added to mix (as both Obama and Boehner agree would be preferable), if tax reform is urgently needed (ditto) and if there are egregious loopholes that could be closed as part of such reform (as Obama continues to agree and Boehner at least used to agree as of two months ago), then there is actually a chance for a bargain that could in the overall mix address most if not all of the stupidity involved in the sequester cuts (many of which will actually wind up costing the government money in the long run, at least in terms of higher unemployment benefits).

The opportunity to put all these matters on the table could come with the return of the "debt ceiling" deadline late this spring -- which started this whole mess back in 2011 when everyone agreed to the sequester as a way to address Republican demands for "dollar-for-dollar" budget cuts to raise the debt limit and prevent default. Boehner now has his "discretionary" budget cuts, so what he has left to ask for are reductions in "non-discretionary" items like Social Security and Medicare. Obama has his tax rate increase, so what he has left are the loopholes: and the sense that Boehner and the Republicans do not have the stomach to again put the nation at risk of default, which they paid a heavy price for in the 2012 election and in their popularity with the public.

The cover for both sides to meet somewhere in the middle and satisfy both their interests (apart from Tea Party die-hards) could well be the umbrella of "tax reform," particularly since both Social Security and Medicare are deeply entwined with our overall federal tax system. While no adjustments in their respective taxes are really on the table, COLA adjustments and means-testing -- as well as future eligibility ages -- will be. The president will never go along with Congressman Ryan's "voucher" plan for Medicare -- we don't hear much about that since the election -- but he is now prominently on record as offering to deliver his party on COLA and means testing cuts. Republicans can no longer argue, as they have during the sequester debate, that Obama "won't touch entitlements."

A tax reform package -- with rate cuts for corporations and individuals -- could give Boehner enough cover to respond to public outcry over the sequester cuts and give on loophole closing if he can claim credit for "forcing" entitlement cuts in return. It will be a bit harder for the Tea Party to side with Wall Street (i.e., Cayman Island) hedge funds by rejecting the very entitlement cuts that were a core element of their "platform" with nearly $4 trillion of budget cuts already in hand: that should be enough to cover the next step up in the debt ceiling if entitlement cuts are in the mix.

Of course all Washington will focus on the "devil in the details" of any tax reform deal -- Obama has to win something on trimming tax benefits for companies that shift jobs overseas, just as Boehner will need to deliver on some form of tax-reduced repatriation of the trillions currently held overseas by American exporters of goods and services and intellectual property. But both sides can live with deals on these issues if the overall package is sellable to their broader constituencies (not just their "bases"). And the resulting tax system cannot be held to a strict "revenue neutral" posture but instead must contribute some "additional" revenue toward reducing the deficit: That would be a "give" by Boehner that must be enticed by a serious enough change in entitlement structure "down the road" to allow him to claim a real victory, as the president will surely do on the "closing the loopholes" issue.

All during this period, the Federal Reserve will continue to give the politicians time to work something out by keeping floor under the stock market and a cap in interest and mortgage rates with their bond-buying "QE." But that won't last much beyond this fall, so no deal on entitlements and taxes means this issue will go to the 2014 election. That said, the other major factor working in favor of some fiscal compromise will be the improved chance for actual Congressional votes on immigration reform and gun-related legislation. Any victorious compromises on those fronts will set a tone of bargaining success that will be hard for both the Tea Party and the far left to stand against.

At the end of the day, a benign result will turn on whether any deal is actually "balanced" -- not in the same sense Obama has used the word in terms of cuts versus taxes -- but rather in terms of political wins for each side. So far both sides have only have wins that are in large part losses.

The road to a "win-win" will run on the rocky ground of tax reform, and through the phantom tollbooth of the debt ceiling -- just as it always has.

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