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U.S. President Barack Obama acknowledges House Speaker John Boehner on Friday ahead of talks on resolving the fiscal impasse. (Carolyn Kaster/AP)
U.S. President Barack Obama acknowledges House Speaker John Boehner on Friday ahead of talks on resolving the fiscal impasse. (Carolyn Kaster/AP)

Obama, Game Theory and the Fiscal Cliff Add to ...

In Washington, everyone is talking about the Fiscal Cliff. If you aren’t mesmerized by foreign budgetary debates and this is new to you, read this quick explanation from the Economy Lab and then come back.

The standoff between President Obama and Republicans in the House of Representatives is often compared to a game of chicken.

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In the most memorable image of the sport, James Dean and his opponent hurl themselves toward a cliff in their cars; the first one to jump out is labelled a “chicken.” Unfortunately for the opponent, his jacket snags on the car and his game ends with his death.

Chicken – or Hawk-Dove – is also an established tool in the science of game theory. As I have explained previously, this is a two-player game where both players would mildly prefer the other to yield, but where neither yielding is the worst possible outcome.

The key part of chicken is that both parties face similar penalties for each choice.

In the application to Rebel Without a Cause, the options are shame or certain death, and they apply equally to James Dean and the other boy. In economics, the options may be to make a dollar or lose ten dollars. When applied to nuclear war in the Cold War, the options were typically losing face and some strategic advantage, or mutually assured destruction.

What is interesting about the current impasse is that the penalties are very different for the Democrats and the Republicans.

For Republicans the penalties are clear, and both routes are bad ones.

As David Frum wrote recently, the no-new-taxes pledge “is the tie that binds Republicans in Congress and Republicans in the country. Compel Republicans to recant that commitment and Republican unity suddenly dissolves. The discipline of their congressional caucus will break. Their base will rebel. Their leaders will quarrel with each other.”

If the Republicans compromise, taxes go up for some.

If the Republicans don’t compromise, taxes go up for all.

Any move to raise taxes would shatter their coalition on its fundamental organizing principle, even a move supported by the vast majority of Americans like a millionaire’s tax.

But failing to move will have an even worse policy result from a Republican lens, raising taxes on the wealthy and those of more modest means.

An ideological commitment to hold the line on millionaire’s taxes is a pretty weak explanation for forcing a recession and raising taxes on blue-collar workers.

Republicans will have a hard time going back to their district and saying “It’s President Obama’s fault you lost your job again and your taxes went up, because I did the right thing and held my pledge to keep even Donald Trump’s taxes down.”

The Republican situation is lose-lose.

In contrast, Mr. Obama’s outcomes are not as bad.

If he fails to get a deal with the Republicans, the economy will suffer – perhaps gravely. The rising of income taxes across the board, the increase in payroll taxes and the sudden sharp drop in public sector spending would definitely slow growth and perhaps drive the United States into another temporary recession.

This could harm his party in the 2013 mid-term elections and squander his remaining political capital.

The alternative is putting some water in his wine. He could be left raising taxes through closing loopholes and on the ultra-wealthy, and cutting spending programs that are important to Democrat constituencies.

The grassroots of Mr. Obama’s party would be upset, and he may lose some votes from Democrats in Congress on centrist projects like trade deals or energy projects.

Mr. Obama just won re-election. He will never run for public office again. He has four years for the economy to turn around. Frankly, deep and unpopular moves that raise taxes and cut spending will produce short-term pain and long-term benefits that will burnish Mr. Obama’s record to look like Bill Clinton’s.

President Obama will be able to point to the Republican intransigence as a short-term explanation for why everyone’s taxes are going up, while wearing the “deficit buster” mantle in history textbooks.

The calculation was made correctly that Mr. Obama has politically less to lose than the Republicans.

However, game theory differentiates between single games and “repeated games,” that is some number of repetitions of the same game over and over again.

U.S. budget making is a series of these repeating games.

Obama’s advantage is in this round. If all the parties agree to go over the fiscal cliff – and taxes go up and spending down – the next round will take place in that atmosphere.

Democrats will want to lower taxes on lower-income constituencies newly added to the tax rolls with the Bush-era changes expired and will need to cut a deal with Republicans to do that.

Moreover, the Republican reputation as “tax fighters” will be gold plated, creating the Clinton-era tax levels to which the system will revert as a long-term ceiling on taxes that can only come down due to Republican demands.

Most importantly, political stability remains dangerously high. It was political instability that drove debt downgrades last year, not the economic fundamentals. Failing to get a deal will reinforce opinion that the U.S. is incapable of making big decisions, a perception sure to strengthen regional rivals in Asia and the Middle East.

Mr. Obama is smart to use his leverage to get a deal, not to exact short-term political violence on the Republicans. If he can set the United States on a gradual path to fiscal stability, he also sets the country on a gradual path to political stability, and fulfills his 2008 promise to remake politics in Washington.

Andrew Steele is a social entrepreneur and political observer living in Toronto.

 

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