More cliffs to come

‘You never want a serious crisis to go to waste,” Rahm Emanuel famously told a group of corporate executives a little more than four years ago, when he was President-elect Obama’s chief of staff. Emanuel’s words apparently have been forgotten in the nation’s capital, where lawmakers manufactured a potentially serious crisis by timing billions of dollars of tax cuts to expire at the end of 2012, days before huge across-the-board spending cuts were set to take effect. The deal that the Obama administration struck this week with Congress to avoid sending the country over this so-called fiscal cliff did little more than push the tough bargaining off for another day, when the stakes may actually be higher.

We reached this point because Democrats and Republicans have repeatedly failed to reconcile their political and philosophical differences over the struggling economy and the mounting federal debt. The outlines of a “grand bargain” seem obvious: higher taxes, less military spending and slower growth in entitlements, particularly Medicare and other healthcare programs. Such a deal requires members on both sides to depart from party orthodoxy, which means it requires both political courage and the right incentive to act.

One might have thought the fiscal cliff provided that incentive, with the government’s top economists warning that the country would quickly fall into another recession if the across-the-board tax hikes and spending cuts went into effect. Nevertheless, the grand bargain again proved elusive. Granted, the GOP agreed to the first major increase in tax rates in almost two decades, albeit only on some of the households in the top bracket. But the compromise that Senate Minority Leader Mitch McConnell (R-Ky.) worked out with Vice President Joe Biden raised less than half the revenue President Obama sought, and included none of the simplifying, pro-growth reforms both sides say they support.

PHOTOS: Scenes from the ‘fiscal cliff’

The spending cuts, meanwhile, were put on hold for two months, buying time for more talks. But those negotiations will be held in an even more ominous context because the Treasury has reached the limit of its borrowing authority. Republicans are eager to repeat the fight they had with Obama over raising the debt limit in 2011, despite the fact that their willingness to stiff creditors caused the first-ever downgrade in the U.S. credit rating.

Obama insists he won’t negotiate over the debt ceiling this time around, and Democrats seem to believe that they can extract more tax hikes in return for agreeing to curb spending on entitlements. This week’s deal, however, appears to have drained their leverage. In other words, a grand bargain large enough to put Washington’s finances in order may be even harder to reach in a month or two. And the risk is that an impasse will lead the government to default, a calamity that could drive up interest rates, injure the economy and exacerbate the government’s fiscal problems.

The compromise that McConnell worked out with Biden wasn’t a complete washout. It renewed the extended unemployment benefits in states with the highest unemployment rates, including California, and it stopped the gradual expansion of the alternative minimum tax by adjusting its threshold for inflation. It avoided a steep cut in fees that could have driven many doctors out of the Medicare program while continuing a tax break that improves the work incentives for low-income families.

Wall Street investors certainly seem to believe the pact was better than no deal at all. But that doesn’t mean it was a good deal, or that Washington’s seemingly endless rounds of fiscal brinkmanship are finally over.