Fiscal Cliff Deal: The President's Latest Counter Offer

Equity and commodity prices rallied in Europe and Asia while the U.S. dollar and Treasury bond prices fell as U.S. President Barack Obama and Republican House Speaker John Boehner have made progress on a fiscal cliff deal.

On Friday afternoon, Speaker Boehner called the White House with an offer to raise taxes on Americans earnings more than $1 million, altering his position on no tax increases for anyone.

With that concession in hand, the president devised a counteroffer, which was presented to the Republicans late Monday. The president's new proposal reduces tax increases from $1.6 trillion over ten years to $1.2 trillion, offset by $1.2 trillion in spending cuts.

But Republicans are questioning the president's math.

"Any movement away from the unrealistic offers the President has made previously is a step in the right direction," Boehner spokesman Brendan Buck said. "But a proposal that includes $1.3 trillion in revenue for only $930 billion in spending cuts cannot be considered balanced."

Fiscal Cliff Deal Will Change Taxes, Debt Ceiling

The president's counteroffer proposes higher taxes for those earning more than $400,000 a year, raising the higher tax threshold from the president's initial proposal of income greater than $250,000. The tax rate on dividends and capital gains would rise from 15% to 20%.

President Obama also abandoned his demand that the debt ceiling be eliminated, instead asking for a new debt ceiling that would cover an estimated two years of spending.

If an agreement on raising the debt ceiling is reached as part of the fiscal cliff negotiations, it would remove the threat of a U.S. government default from the economy for next year at least.

The U.S. government is expected to hit its borrowing limit by the end of December. Extraordinary measures by the Treasury Department can keep the lights on until February or March but, after that, Congress must extend the debt ceiling or risk default.

Social Security Cut, Taxes Raised

Perhaps the most controversial part of the president's proposal is a change in the method of calculating cost of living adjustments (COLA) for Social Security beneficiaries, veterans' pensions and Medicare and Medicaid.

Cost of living adjustments are intended to offset the impact of inflation on the value of pension benefits, such as Social Security. Tax brackets are also adjusted each year using the same COLA calculation.

The president has proposed using "chained CPI" to calculate cost of living adjustments. Chained CPI attempts to take into account changes in consumer behavior in reaction to prices.

For example, if the price of beef goes up but pork prices are stable, chained CPI assumes that consumers will switch from beef to pork. In this way, COLA does not fully reflect the higher price of beef, reducing the amount of Social Security and other benefits paid out to beneficiaries.

Chained CPI would move taxpayers into higher brackets more quickly since the COLA using chained CPI would be smaller than the current calculation.

The impact of switching to chained CPI is small in early years but, like a snowball rolling downhill, gets bigger and accelerates in later years.

In addition, the president is not seeking an extension of the payroll tax cut, a temporary stimulus measure which reduced the amount taxpayers pay into Social Security and Medicare. That means that nearly all wage earners will see their take-home pay decreased beginning in January.

Markets Rally on Fiscal Cliff Deal Progress

Optimism over the sudden progress in the fiscal cliff deal has sent equity prices higher in Europe and Asia overnight. Commodities, including gold, have rallied.

U.S. stock futures are higher, Treasury prices are lower. The U.S. dollar is weakening against the euro and sterling but is weaker against the yen.

If a bipartisan agreement can be reached on avoiding the fiscal cliff that includes an extension of the debt ceiling, it would be a great relief to the markets as the U.S. economic recovery would be allowed to continue.

There is still a way to go before a fiscal cliff deal is finalized. Republicans do not agree with the president's budget math, disagreeing that $290 billion in interest saved is a spending cut.

Democrats are going to fiercely oppose the move to chained CPI for calculating cost of living adjustments. Payroll taxes are going to rise and Boehner is offering only a one year deal on the debt ceiling.

We'll see today if the GOP comes back quickly with another proposal for a fiscal cliff deal.

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