(Bloomberg) The U.S. Senate passed a bipartisan budget deal two hours after income tax cuts expired, reaching an after-deadline deal to undo the potential economic harm of $600 billion in tax increases and spending cuts.
The vote early today in Washington shifts the pressure to House Speaker John Boehner, who hasn’t said if he’ll accept the agreement or change it. He will face difficulty mustering Republican votes for any bill with higher taxes for 2013 than they were in 2012.
The Senate bill, passed 89-8, would make permanent the tax cuts for most households that expired at midnight, continue expanded unemployment benefits and delay automatic spending cuts for two months.
“While neither Democrats nor Republicans got everything they wanted, this agreement is the right thing to do for our country and the House should pass it without delay,” President Barack Obama said in a statement released by the White House this morning.
The agreement isn’t the grand bargain on deficit reduction lawmakers hoped for when they created the conjoined tax-and- spending deadlines over the past three years. Instead, if the agreement becomes law, it would avert most of the immediate pain and postpone Congress’ fiscal feud for just two months -- until a February fight over raising the $16.4 trillion debt limit.
“There are many, many reasons why people dislike portions of this bill, but there’s close to unanimity that it’s better than going over the cliff,” said Senator Charles Schumer, a New York Democrat.
Minimal Effect
If brief, the dive off the so-called fiscal cliff would have relatively minimal effects on many households and would avoid the recession that a longer lapse would cause. Still, the expiration of a payroll tax cut and the higher taxes for top earners will probably slow the economy, reducing growth in the first quarter to 1 percent from 3.1 percent in 2012’s third quarter, according to economists at JPMorgan Chase & Co.
“Underneath the fiscal drama is an improving economy,” said Ryan Sweet, a senior economist at Moody’s Analytics. “The fiscal drag will take some wind out of it but once there is more clarity, we can expect stronger growth.”
Ahead of a potential deal, the Standard & Poor’s 500 Index jumped 1.7 percent to 1,426.19 at 4 p.m. yesterday in New York for its biggest gain since Nov. 19. Ten-year Treasury yields were up six basis points at 1.76 percent, still the lowest-ever year-end close. The Japanese yen weakened, capping the biggest annual drop versus the dollar in seven years. Gold extended a 12th annual gain, the longest streak since at least 1920.
Biden and McConnell Strike a Deal
The agreement, reached in the waning hours of 2012, was brokered by Vice President Joe Biden and Senator Mitch McConnell of Kentucky, the chamber’s Republican leader. Obama met with his staff until 2 a.m. on Dec. 31, and Biden sold the agreement to Senate Democrats in a two-hour New Year’s Eve session in the Capitol.
Obama spoke with Democratic leaders in Congress last night before Biden came to the Capitol and hadn’t spoken with Boehner as of about midnight, said people familiar with the talks.
Three Democrats voted against the measure: Michael Bennet of Colorado, Tom Harkin of Iowa and Tom Carper of Delaware. They were joined by five Republicans who voted no: Chuck Grassley of Iowa, Mike Lee of Utah, Rand Paul of Kentucky, Marco Rubio of Florida and Richard Shelby of Alabama.
Compared to continuing current policies, the agreement would increase taxes by $620 billion and cut spending by $15 billion, according to people familiar with the negotiations.
Rare Agreement
The bill marked a rare bipartisan agreement for lawmakers who have been trying for more than two years to reach an accord on taxes and spending, hurtling from deadline to deadline. Even this least-common-denominator agreement required brinkmanship and came after weeks of partisan bickering.
“It’s not the big, bold, bipartisan deal that we need, that the markets need, that our country needs, but a smaller deal that still provides some confidence to 98 percent of American families and small businesses that their tax rates won’t go up,” Senator Chris Coons, a Delaware Democrat, said on Bloomberg Television. “So while it’s not what I had hoped, it is at least some progress in dealing with the fiscal cliff.”
Winning passage in the House will require a sales job by leaders who are trying to resist pressure from the ideological fringes of their parties. House Republicans oppose tax increases for any income level and many may resist a bipartisan Senate deal that lacks spending cuts. Some Senate Democrats opposed the bill because it didn’t raise enough revenue.
House Republicans
The House could vote as early as today. Boehner has said the House could change whatever the Senate passes, sending it back to the Senate for a final vote.
“The House will honor its commitment to consider the Senate agreement if it is passed,” Boehner and other Republican leaders said in a statement. “Decisions about whether the House will seek to accept or promptly amend the measure will not be made until House members—and the American people—have been able to review the legislation.”
Senators said they hoped bipartisan support would prompt the House to accept the deal.
“The speaker has said all along that he was waiting for the Senate to act,” Senate Majority Leader Harry Reid said. “Now I hope for America that he will allow the full House of Representatives to vote on this bipartisan legislation.”
Real Deadline
In some sense, the real deadline is noon on Jan. 3, when the current Congress leaves office and the new Congress will be sworn in. The process would have to be restarted with dozens of new members, including a stronger Democratic majority in the Senate and a smaller Republican majority in the House.
The deal passed by the Senate would raise tax rates on income of individuals above $400,000 and married couples above $450,000. That’s double the individual threshold Obama campaigned on and 80 percent higher than his preferred level for married couples.
Still, Obama used the leverage from his re-election and the expiration of the tax cuts to force Republicans to break their no-tax-increase position. The top rate would go to 39.6 percent, up from 35 percent.
The top rates on capital gains and dividends would increase to 23.8 percent starting at the same income thresholds, including a 3.8 percent tax that starts today on top earners. Limits on personal exemptions and itemized deductions for top earners that had been phased out will return, for individuals starting at $250,000 and married couples starting at $300,000.
Estate Taxes
Estates would receive a more-than $5 million exemption and 40 percent top rate, splitting the difference on rates between Republicans and Democrats. The exemption would be indexed for inflation. The alternative minimum tax would be permanently fixed to prevent it from expanding to more households.
For ultra-high-net-worth families, the estate tax rate—rather than the exemption—is most important, said Jere Doyle, senior wealth strategist at Bank of New York Mellon Corp. whose clients usually have at least $10 million in net worth.
“What the marginal dollars are taxed at, whether it’s 35, 45 or 55 percent, that’s the big deal,” Doyle said. “The exemption is a drop in the bucket for a lot of wealthy people.”
Expanded unemployment benefits would be extended for a year, and tax breaks for low-income families would be continued. That costs about $30 billion and isn’t offset with spending cuts, according to people familiar with the talks.
Spending Cuts
The automatic spending cuts, which were the biggest stumbling block yesterday, would be delayed for two months from their scheduled start date of tomorrow.
Half of the $24 billion cost of delaying the cuts would be covered by allowing 401(k) retirement account holders to convert some of their balances into Roth-style accounts that can be tapped tax-free in retirement, said a Senate aide familiar with the talks.
The change would raise revenue because people who do such conversions pay income taxes up front. The conversions aren’t currently allowed in 401(k) plans, the aide said.
The other half of the spending cuts would be prevented through replacement spending cuts, half in defense and half in non-defense programs, said Senator Sherrod Brown, an Ohio Democrat.
Miscellaneous tax breaks would continue through 2013, including breaks for corporate research, multinationals’ overseas financing operations and wind energy. Many of those breaks had expired at the end of 2011. Companies would get 50 percent bonus depreciation.
Payroll Tax
The agreement wouldn’t avert all of the tax increases set to take effect this year. A two-percentage-point cut in the payroll tax has expired and isn’t part of the emerging deal.
That will make paychecks smaller in 2013; someone earning $50,000 and being paid twice a month will lose $41.67 per paycheck. The payroll tax cut’s expiration will end transfers from the general fund to Social Security to cover its cost.
Taxes on top earners’ wages and unearned income such as capital gains will take effect, due to the start of revenue increases from the 2010 health care law.
The Internal Revenue Service told employers last night to withhold taxes from paychecks assuming that lapsing tax cuts would expire as scheduled and said it would issue updated tables if Congress passes an extension. Employers should implement the higher withholding by Feb. 15, the IRS said in a statement issued 12 minutes before midnight.
Debt Ceiling
The agreement also sets up yet another fiscal fight, this time over raising the U.S. debt ceiling, which reached its $16.4 trillion limit yesterday.
Treasury Secretary Timothy F. Geithner began taking so- called extraordinary measures to finance about $200 billion in debt this year. Under normal circumstances, that would last about two months.
Republicans say they’ll use the leverage created by the debt ceiling to force Obama to accept spending cuts, particularly in entitlement programs.
Obama resisted that notion yesterday, saying he wants more tax increases that would come in part from limiting tax breaks and that he won’t accept Republican plans to “shove” spending cuts past him.
“If they think that’s going to be the formula for how we solve this thing, then they’ve got another thing coming,” he said. “That’s not how it’s going to work.”
—With assistance from Inyoung Hwang, Whitney Kisling and Margaret Collins in New York and Heidi Przybyla, Roxana Tiron, James Rowley, Rich Miller, Shobhana Chandra, Peter Cook and Margaret Talev in Washington. Editors: Jodi Schneider, Michael Shepard
