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Congress may OK short-term stimulus, but fiscal train wreck looms

The signs look hopeful for a short-term accord in Congress on extending the payroll tax cut and unemployment benefits.

But right after Election Day, a lame-duck Congress will face a horrific fiscal train wreck: sharp tax increases, combined with automatic spending cuts -- and scanty reserves of political goodwill to help clinch a deal to avert that outcome.

A House-Senate conference committee met Thursday to try to push ahead with a full-year payroll tax cut. The committee will keep working next week as Congress heads to a Feb. 29 deadline.

Also as part of that deal, there’s bipartisan accord on the committee to not allow Medicare spending cuts enacted in 1997 to take effect. The payroll tax cut package will include another in a long series of postponements of the cut in Medicare payments to doctors.

At the same time that the House-Senate conference committee was meeting Thursday, five Republican senators, led by Arizona Sen. John McCain, were vowing they’d block the roughly $100 billion cuts in spending -- called the “sequester”-- mandated by last year’s Budget Control Act and set to occur in January. Half of those cuts would come from defense outlays.

Two of those five senators, Kelly Ayotte of New Hampshire and Lindsey Graham of South Carolina, voted against the Budget Control Act; but three of the five, McCain, John Cornyn of Texas and Jon Kyl of Arizona, voted for it.

Graham painted picture of a Budget Control Act that was beginning to unravel – and not a moment too soon, from his point of view. “I think there will be a lot of bipartisan support to abandon the sequestration provisions” in the Budget Control Act, he said, “because they are unwise and quite frankly dangerous.”

Because the Budget Control Act mostly exempts entitlement spending from automatic cuts, it’s the other big item in the budget, defense, which must bear the brunt of the cuts.

The GOP senators’ proposal was to avert the sequesters for one year by cutting the cost of the federal government elsewhere: hiring only two workers for every three who retire or leave federal employment.

They’d also maintain the freeze on federal employee pay until mid-2014. (The House voted Wednesday night to keep the federal pay freeze for this year and next year.)

McCain said even before the automatic cuts mandated by the Budget Control Act, the Obama administration plans to slice $487 billion from defense outlays over the next ten years. McCain and the other Republicans cited Defense Secretary Leon Panetta’s warnings that the additional sequesters on top of the already planned defense cuts would be “devastating.”

While the GOP senators cited Panetta as authority for averting the defense cuts looming in January, they slammed him for the comment he made Wednesday that U.S. forces in Afghanistan would end their combat role as early as mid-2013, the first time that he has pinned a date on the end of combat. American troops are scheduled to be out of Afghanistan by 2014.

But the GOP senators may face a public perception challenge: if the average taxpayer knows that U.S. troops have departed from Iraq and if he hears Panetta’s end-of-combat in Afghanistan forecast for 2013, he might wonder: Why can’t Congress cut defense spending further?

 Graham gave a nod to the presidential politics, saying, “This administration is focused on leaving because of the November elections.” President Obama, he said, “wants to tell the American people ‘I got us out of Iraq and Afghanistan.’”

That might be a more crowd-pleasing campaign message than what Graham sketched out: a U.S. commitment in Afghanistan until 2014, followed by a security agreement with the Kabul government “where you would have three to four airbases left behind… with American airpower, helicopters and Special Forces units, that would be available to Afghan security forces as far as the eye can see….” He estimated this would take 15,000 to 20,000 U.S. forces on the ground “and the Taliban would never come back.” And at that point “then you sit down and negotiate” from a position of strength.

For now, Republican hawks don’t want to talk about tax increases as a way to avert defense cuts.

“Let’s not let a domestic issue such as a tax increase interfere with what could be ‘devastating’ in the words of our secretary of defense to our nation’s security,” McCain said.

“Defending our country is not the cause of our fiscal crisis,” Ayotte said. “The notion that defense spending is the driver of the larger fiscal crisis is not the case. Roughly 60 percent of our spending is entitlements.”

The 2012 figure for the three biggest entitlements (Social Security, Medicare and Medicaid) is 44 percent of total federal spending, but the CBO’s annual budget report this week said entitlement spending will nearly double in the next ten years.

The three big entitlements will go from 44 percent of total outlays to 55 percent, while defense outlays slip from 19 percent of federal spending to 13 percent.

But that entitlement growth is significantly understated because the CBO “baseline” forecast assumes that Congress will do exactly what the House-Senate conference committee Thursday had already agreed to not do: cut Medicare’s payments to doctors.

There was a bit of good news in the CBO forecast: revenues are improving. The CBO said that in 2011, individual income tax revenues jumped by $193 billion, or 21 percent. Even with high unemployment those who are working are earning more and paying more in taxes. Overall, revenues were up 6 percent in 2011 and CBO expects them to increase by 9.6 percent in 2012.

And then between 2012 and 2014, revenues are scheduled "shoot up by more than 30 percent," the CBO report said, but that, again, assumes that Congress will do what it’s almost certain to not do: allow the scheduled expirations of the current income tax rates and the scheduled increase in the reach of the alternative minimum tax.

 A Democrat who serves both on the payroll tax conference committee and on the Armed Services Committee, Rhode Island Sen. Jack Reed, sees room for progress toward averting a fiscal train wreck.

“If we can successfully conclude this (payroll tax) conference,” he said, “that’s a good sign that we can start dealing more constructively, cooperatively and effectively with the whole set of budget issues.” This would, he said, “set a good precedent” for dealing with the looming sequesters.

Democrats and Republicans can agree to at least discuss both spending and additional revenues, he said, “so that we don’t get into austerity measures that are leading to zero or negative growth and making deficit problems worse” in countries such as Greece and Spain.