Fiscal Cliff: A Game Theory Showdown

My co-author and I thought it would be interesting to perform a basic Game Theory- Prisoner's Dilemma Analysis concerning the fiscal cliff debate.

The Game will be based on a 0 to 100 payoff. So lets assume that the principal goal of the President is to protect entitlements by raising taxes on the very rich in the country. Raising taxes on the rich will produce optimal payoffs for the President. Now lets assume that the principal goal of the Republicans is to pass a deal without raising tax rates on the rich. Similarly, the Republicans will obtain very high payoffs in a scenario that does not raise taxes on the rich. The following chart illustrates the analysis.

It is important to note that the game is simultaneous.This Game represents the political outcomes of the fiscal cliff negotiations. Also, this is a theoretical simulation from one particular viewpoint. It is meant to spark a discussion, not tell the future.

Best Response for President if Republicans don't go over cliff = Propose deal to raise taxes on rich=100

Best Response for President if Republicans go over cliff= Propose deal to raise taxes on the rich =60.

Best Response for Republicans if the President proposes to not tax rich=Don't go over cliff=100

Best Response for Republicans if the President proses to tax the rich=Don't go over Cliff = 25

In this scenario the President will receive the optimal payoffs from proposing a deal that includes tax hikes on the rich, even if the country goes over the fiscal cliff. For example, the President will retain his political support  to continue his agenda because the American people support taxing the rich. Taxing the rich is part of the President's plan to protect entitlements for the middle class. In addition, the President still receives a higher 60 payoff if the country goes over the cliff and the President proposes to raise taxes. This higher payoff is the result of taxes going up on the wealthy as the country goes over the fiscal cliff. Also, the 60 payoff is the result of the President staying true to the political will that supports tax hikes on the rich. Dissimilarly, the President only receives a 50 payoff if he does not support tax hikes and the country goes over the fiscal cliff. This result is due to the fact that the President submitted to the Republicans and did not fight for tax hikes on the rich. For example,if we go over the fiscal cliff and the President does not fight for tax hikes to protect entitlements, he will lose political points.

The Republicans receive the highest payoffs from not going over the cliff.For example; if the Republicans do not allow the country to go over the cliff and the President offers a deal with no tax rate hikes, the Republicans win everything they wanted. If the President proposes a deal with tax hikes and the Republicans do not go over the cliff, the Republicans will still obtain a 25 payoff because they save some political face for not going over the cliff. The Republicans also save some political face for preventing tax hikes on the middle class. However, the Republican base will be disappointed that the Republicans submitted to the Democrats.

The last chart will display the most probable strategies:

Best Repsonse For President if Republicans don't go over cliff=Propose to raise taxes on rich=100

Best Response for President if Republicans go over cliff= Propose deal to raise taxes on the rich =60.

Dominant Strategy for the President is to Propose a deal to raise taxes.
Best Response for Republicans if the President proposes to not tax rich=Don't go over cliff=100
Best Response for Republicans if the President proses to tax the rich=Don't go over cliff = 25
Dominant Strategy for Republicans is to not go over over the cliff.

So in Conclusion, my co-author and I hypothesis that the President will continue to propose a deal to raise taxes and the Republicans will not go over the fiscal cliff.

Note:
Nash Equilibrium was invented by Dr. John Nash.