The Debt Ceiling negotiations and the expiration of the Bush tax cuts give President Obama not only the greatest challenge, but also the greatest opportunity of his Presidency. Follow me below the kinky croissant if you want to understand how the President can turn this crisis to his (and America's) advantage and achieve one of the greatest progressive transformations of the political and economic landscape since the New Deal and Great Society of FDR and LBJ:

The US Congress must approve any increase in the US debt ceiling on a regular basis because, even when the debt is not rising as a % of GDP or adjusted for inflation, it is still rising in nominal terms. Debt as a % of GDP is the standard way of measuring the sustainability of debt, and so increasing the debt ceiling is no big deal in economic terms as long as the economy is also growing just as fast over the medium or long term.

Increases in the debt ceiling used to be routine, but in recent years Republicans have used them as an opportunity to force the Obama Government to make swinging cuts in Government expenditure and thus achieve the conservative aim of limited Government. Indeed, this is a major change from their attitude when a Republican President is in power.

"Reagan," Vice President Dick Cheney famously declared in 2002, "proved deficits don't matter." Unless, that is, a Democrat is in the White House. After all, while Ronald Reagan tripled the national debt and George W. Bush doubled it again, each Republican was rewarded with a second term in office. But as the Gallup polling data show, concern over the federal deficit hasn't been this high since Democratic budget balancer Bill Clinton was in office. All of which suggest the Republicans' born-again disdain for deficits ranks among the greatest - and most successful - political double-standards in recent memory.
Last year negotiations on a debt ceiling increase became so fraught that a default on US debt was threatened and the US credit rating was reduced for the first time in US history. Agreement was eventually reached to raise the ceiling pending further negotiations on expenditure reductions, and the Bowles-Simpson Commission was set up to come up with proposals to do so. The Bowles-Simpson Commission proposed a "sequestration of expenditures" - swingeing cuts in defense and other expenditure to come into effect in January 2013 if no agreement is reached.

In addition, the Bush tax cuts are due to expire in January 2013 unless they are further extended by congress. President Obama proposed extending them for all families earning less than $250,000 p.a. but Republicans insist they should be extended for all tax payers regardless of income. The combined effect of the tax cuts coming to an end (thus raising income tax levels) and the Bowles-Simpson Commission sequestration of expenditures coming into effect at the same time would be so deflationary, than many economists predict that the US economy would lurch back into recession.

There is thus a huge game of bluff and counter bluff being played out between the President and the Republican dominated congress at the moment, as to whether the Bush tax cuts should be extended to all (as the Republicans want) and as to whether the debt ceiling will be raised again to avert the Bowles-Simpson cuts in expenditures many of which - particularly those in defense - Republicans do not particularly want either.

Many progressives are urging the President to call the Republican's bluff and let the Bush tax cuts lapse and the defense expenditure reductions kick in - in other  words, to let the economy fall off the "Fiscal Cliff" -  in the belief that Republicans would then quickly cave in and agree to a raising of the debt ceiling in return for no reductions in military expenditure and at least some extension of the Bush tax cuts beyond what the President proposed and campaigned on.

However Republicans have shown a willingness to allow the US economy to deflate by opposing the Stimulus Plan, the Auto-bailout, the previous attempt to raise the debt ceiling, and the President's Jobs Bill - aimed at increasing employment. Indeed it was a key part of their plan to prevent the President's re-election by painting him as unable to manage the economy. Whether they will change their tune now that he is re-elected for the next four years, is open to debate. It is possible that their financial backers in Wall Street and industry more generally will tell them that the price of any further political opposition to the President on this issue is simply to high in terms of corporate profits forgone.

But what if Congressional Republicans simply dig in and refuse any further raising of the debt ceiling and approval for any Budget the President proposes which doesn't include even more swingeing expenditure reductions in social and health care entitlements? The early indications are that they are digging in for a long war against the President, and Democrats more generally, in an effort to retain as much political power as possible. What if no agreement is reached, and the President is faced with a situation where the tax cuts lapse and the Bowles-Simpson Commission proposed a sequestration of expenditures kick in resulting in the US economy sliding into recession?

I would like to propose a strategy the President might use to avert recession and circumvent the debt ceiling, or at least force the Republican's hand to come up with a proposal more acceptable to Democrats. Suppose the President were to do the following early in 2013 once the Bush tax cuts have lapsed, and the  Bowles-Simpson Commission cutbacks have kicked in:

1. Announce immediate and huge reductions in US military procurement. Republicans, and their financial backers in the Military Industrial complex would be absolutely furious even though the effect on US military capabilities would be very gradual and long term. This would have a deflationary effect on the US economy as manufacturers cut back on production, although some might be able to find other markets overseas thus reducing the deflationary effect.

2. Announce a significant reduction in US forces and bases worldwide including an accelerated withdrawal from Afghanistan. Democrats would not be unduly alarmed, for the most part, progressives would be pleased, and Republicans would be aghast. The effect on the US economy however would be minimal as the expenditure reductions are in external markets, and bringing more troops home might actually increase domestic consumption.

3. Announce a US Government zero interest "loan" program for middle class families who are effected by the cessation of the Bush tax cuts at least equivalent to the additional taxes they might have to pay - but also available to the poorest families who are not liable to pay income tax at all. The fact that it is a loan program means that the debts are technically in the names of those families, and do not increase the US Government's debt. The effect of these loans would be to enable these families to maintain (or in the case of the poorest families to increase) their disposable "income" and thus their levels of consumer expenditure.

The economic effect of these loans would be to negate the deflationary impact of the tax increases and maintain and increase the consumer expenditure component of GDP. In addition, because lower income groups tend to spend a greater proportion of their income domestically, the multiplier effect of such domestic expenditures would be much greater than if that same "loan" had been given to top earners who would spend a greater proportion of that loan on imported goods or indeed spend it directly abroad. The net effect of these loans would then actually be to grow the economy more and counteract the deflationary effect of the ending of the Bush tax cuts and the reductions in Military expenditure.

Of course Democrats would promise that these loans would be forgiven and made permanent as soon as Democrats managed to achieve control of Congress. If Republicans opposed these proposals, they would effectively be campaigning for tax increases. The effect of the loan program would be far more progressive than any tax reduction, because even low income families who do not qualify for income tax would qualify for the loans. In addition the Republican threat to "tank" the economy would be negated, and many of their favorite military spending programs would be cut. Some of those military expenditure reductions would have been enabled in due course by the ending of the Afghanistan war in any case, so President Obama can present them as "responsible", even if they ended up happening sooner than planned.

President Obama would only agree to terminate the loan program in return for republican agreement on a long term debt reduction plan which meets his targets for employment creation and health and welfare benefits. Any tax reductions would have to be progressive and help even the poorest families. The public option (which could arguably be introduced by Executive Order) would be back on the table, and the Republican threat to destroy the economic recovery averted.

What's not to like?

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