In their negotiations over the so-called “fiscal cliff,” the Democrats threw away a chance to get more revenue from the wealthy and to introduce modest changes to entitlement funding in order to mollify their base and get the top marginal federal income tax rate back to 39.6%. Although Democrats can claim a negotiating win to their supporters (although many seem ticked the president was not stronger in negotiations), their Pyrrhic victory came at a high cost, in terms of both the foregone revenue and greatly diminished odds of real tax and entitlement reform.

Capping deductions at the level the Republicans first proposed would have raised nearly as much revenue as the expiration of the Bush tax cuts for couples with incomes over $250,000 — and more revenue than was actually achieved in the final agreement (which raised rates on couples with incomes over $450,000). A better negotiating strategy for Democratic leadership would have been to respond to Republicans’ first offer by saying a) we will negotiate with Republicans but the rates have to go up on SOMEONE, and b) we’re going to ultimately need more revenue than what was first proposed. Defaulting to increasing tax rates on people earning over $1 million was House Minority Leader Nancy Pelosi’s position as late as July and would have been a good fallback: Republicans were not prepared to defend people making over $1 million. After all, even Fox News said millionaires’ rates should go up.

From this position, Democrats could have proffered an agreement to deal with the debt limit as the price of giving the Republicans a partial out. Republicans would have likely acquiesced if a debt-limit agreement came with some spending cuts. Throw in the entitlement funding formula change, some phony interest savings, and some not-quite-iron-clad agreement about doing tax reform in the next year that brings in modest revenue increases, and it would have given the two parties a year to actually negotiate tax and entitlement reform. This kind of deal would have allowed the president to have rightfully claimed that there was a new negotiating environment, and the markets (and Congress) could look ahead and see a genuine chance to fix two major impediments to future growth and prosperity.

Instead, the White House decided to attack the capping of deductions as being unfair to charities and people in wealthy states, and as being tantamount to another stealth way for Republicans to protect the rich. And they decided to hold Republicans’ feet to the fire to get a short-term Pyrrhic political victory that forecloses any possibility of a substantive bi-partisan achievement in the next Congress. Democrats went for a tactical short-term victory — which they achieved — at the expense of something much more important.

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