This post was also written by Robert Helland.

With all attention now focused on the campaign for control of Congress and the Presidency, it might be easy to forget that the 112th Congress is still in session and returns to work in September. When Congress does return, a number of important decisions affecting health care and energy policy, among other areas, remain to be considered. Added to this list of issues is the threat that the economy could fall back into a recession, or as some put it – fall off a “Fiscal Cliff” – should Congress fail to stop the tax hikes and spending cuts currently set to take effect January 2, 2013. All of this promises a busy agenda for the next few months, likely stretching into a Lame Duck Session of Congress after the November elections.

Sequestration and Tax Increases: A recipe for recession?

The biggest question is whether Congress will allow the automatic spending cut process it set in motion under the Budget Control Act (Public Law 112-35, “Act”), known as “sequestration,” to proceed. This is just the latest in a series of recent steps under the Act to reduce the federal debt. The first step involved a spending cut of $900 million that only came after the threat of government shutdowns that resulted in the government’s credit rating falling for the first time. The second step involved the so-called congressional “Super Committee,” which was unable to find $1.2 trillion in additional spending cuts. Now those $1.2 trillion in spending cuts will begin to take effect automatically over the next 10 years, with the first installment of $109 billion taking effect January 2, 2013. It will be distributed equally between most defense and non-defense programs, with only a few spared the budget ax (including Social Security and Medicaid). Cuts to Medicare are limited to 2 percent a year. More specifics are expected soon as Congress has passed – and the President signed – the Sequestration Transparency Act of 2012, which requires the Obama Administration to report to Congress as to how it will administer the cuts (Public Law 112-155).

Next in importance is whether Congress will allow a series of tax cuts to expire at the end of the year, as currently scheduled. The expiring tax cuts include the reduction in income, capital gains, estate and gift taxes found in the “Bush Tax Cuts.” Other tax cuts set to expire include the recently enacted 2 percent Social Security payroll tax cut.

In addition, other fiscal measures will need to be decided before the end of the year, including whether to extend unemployment benefits for the long-term unemployed and whether to adjust Medicare’s rates so that physician payments are not cut (the so-called “doc fix”).

If Congress does nothing and allows all spending and tax measures to expire, the non-partisan Congressional Budget Office forecasts the United States economy will fall back into a recession as a result, “with real [Gross Domestic Product] declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013” (www.cbo.gov).

Would there be a ‘Grand Compromise’ and what could it include?

Already, posturing by both parties has begun, to avoid any jumping off that Fiscal Cliff. The posturing includes legislation passed in the House of Representatives that would shift cuts in defense spending to domestic programs (H.R. 5652, the Sequester Replacement Reconciliation Act of 2012). Posturing actions also include legislation passed in the Senate that would limit income tax cut reductions to households making $250,000 or less (S. 3412, the Middle Class Tax Cut Act).

Neither of these bills passed their respective chamber with bipartisan support. But the pressure to compromise will build as Congress gets closer to the edge of the Fiscal Cliff. We expect to see movement on the need to compromise likely, building to a resolution either during a Lame Duck session of Congress or when a new Congress convenes in January. Other spending measures likely to be caught up in this include:

The budget for Fiscal Year 2013 (“FY 13”).  Progress on the 12 spending bills needed to fund the federal government for the next fiscal year has slowed to a stop. This outcome is due entirely to the broader sequestration debate. As a result, Senate Majority Leader Reid (D-NV) announced on July 31 a deal with Speaker of the House John Boehner (R-OH-8) on a six-month continuing resolution (“CR”) that will fund the government through May 31, 2013 (www.dpcc.senate.gov).

Spending for the Patient Protection and Affordable Care Act.  The “power of the purse” is one way, besides outright repeal, that Republicans can limit the effects of the Patient Protection and Affordable Care Act (Public Law 111-148). While the Senate Appropriations Committee has passed appropriations legislation that provides full funding for FY 13, the Sequester Replacement Reconciliation Act of 2012, passed in the House, would not.

Energy policy.  Whether the federal government should be funding efforts that promote the development of renewable energy has been debated in the House of Representatives. On August 1, the House Energy and Commerce Committee passed legislation that would effectively end the Department of Energy’s loan guarantee program by prohibiting any new applications; other congressional reviews are ongoing. Beyond this prohibitory action, however, a number of tax credits are in place that also fund the development of renewable energy and are set to expire at the end of the fiscal year, unless renewed. Notably, the Senate Finance Committee passed a one-year “tax extenders” bill on August 2 and included only an extension in the wind energy tax credit in a package that included tax relief from the alternate minimum tax, as well an extension of the research and development tax credit given to businesses (www.finance.senate.gov).

Considerations

The timing and elements of a final decision on all of these policy, spending and taxation issues will be essentially affected by who wins the White House and Congress in November. But the Federal Government must operate, so decisions must, and will, be made regarding these policy and budget issues. Careful monitoring of upcoming activities may suggest beneficial future strategies.

Please contact the Reed Smith Public Policy & Infrastructure practice, or the attorney with whom you regularly work, if you have any questions regarding this Client Alert.