Cliff diving

On New Year’s Day, the Bush-era tax cuts will expire and mandatory cuts in government spending will go into effect, a double-whammy to the economy that is being called “the fiscal cliff.”  Republicans do not want the tax increases and Democrats do not want the spending cuts.  So Congress is negotiating with the President about compromises, reforms, and trade-offs, all in an effort to avoid what nobody wants, the country going off the cliff.

But might falling off the fiscal cliff, in the long run, be the best solution, despite the horrible short-term consequences?  Under that scenario, taxes would rise dramatically (giving the government more revenue, the Democrats’ dream) but also government expenditures would be cut dramatically (resulting in a smaller government, the Republicans’ dream).  The combination of higher revenues plus lower expenditures would solve the deficit.

Isn’t this a true bi-partisan solution?  Don’t we as a nation need to take our bitter medicine before we can get better?  Other countries, such as Great Britain, have gone through austerity programs as a necessary step to fiscal health.  Could we Americans handle austerity?

(I am not necessarily advocating this, simply proposing for now a mental experiment.  Some of you suggested this in yesterday’s discussion of “Breaking Pledges,” but it’s worth discussing in its own right.)

The blue states’ tax break

In the negotiations to avoid falling off the “fiscal cliff,” Republicans are proposing cutting out tax deductions in exchange for lower tax rates.  I worry about the fate of charitable giving deductions and the impact eliminating them might have on  churches.  (One option being discussed is to just cap them for the wealthy, but many non-profit organizations–museums, colleges, and just about any entity running a capital campaign–depend heavily on big donors.)  Another potential casualty is the home-mortgage deduction, doing away with which may deal yet another blow to the housing market.

These may all make economic sense and, if rates are lowered, individuals may not take a tax hit.  But they will still have consequences.  Charles Lane looks at another IRS deduction that most of us appreciate, that for state and local taxes.  He shows, though, how the most liberal states have been using this provision to soften the blow of raising state taxes, forcing the rest of the country to subsidize their profligate spending:

Taxpayers have been allowed to deduct state and local income and property taxes since the federal income tax began in 1913. (Sales taxes have at times been deductible, too, but that’ s a relatively minor issue.) The theory is it’s unfair to make people pay twice for the public services they receive. That’s doubtful, though, since, despite some overlap, federal taxes support different services than state and local.

What the deduction does is enable higher-income states and localities to tax — and spend — more than they otherwise would, while shifting some of the cost to other states. It also encourages them to collect revenue in forms that are easier to deduct on federal returns.

Two states, California and New York, reaped almost 30 percent of the deduction’s value in 2009, the latest year for which I could find Internal Revenue Service data. Other states that benefit disproportionately include Connecticut, New Jersey, Illinois, Massachusetts and Maryland.

In 2009, 73 percent of the deduction’s benefits went to taxpayers with annual incomes above $100,000, according to the Congressional Budget Office; fully 20 percent of the benefits went to taxpayers with annual incomes above $1 million.

Starting to notice a pattern? Basically, what we have is a significant federal tax subsidy for “blue” state governments. These also happen to be the states having the most difficulty living within their means, what with their expensive urban school systems, bloated pension liabilities and all. Yet they have an incentive to close their budget gaps by raising income taxes rather than reining in spending, because the deduction helps them pass the tab to other states, most of them red.

California Gov. Jerry Brown addressed his budget woes through a referendum this year to boost the top income tax rate, just as Illinois Gov. Pat Quinn pushed an income tax rate increase through his legislature last year.

Now you’re beginning to understand how this seemingly innocuous tax break distorts financial flows within and among the 50 states, as well as between the states on the one hand and Washington on the other.

As for negotiations over a “grand bargain” between President Obama and the Republican House, the state and local tax deduction complicates that process, too.

The main bone of contention is the federal income tax rate on top earners, currently 35 percent. Obama says it is going to be hard to raise enough revenue without returning that rate to 39.6 percent, the level during Bill Clinton’s presidency.

Republicans insist that eliminating deductions and tax breaks could bring in more revenue without raising rates — while getting most of the money from the wealthy, just as the president wants to do.

In fact, the Tax Policy Center, a nonpartisan Washington think tank, has shown that eliminating all itemized deductions while leaving tax rates where they are now would raise $2.2 trillion over 10 years. That’s $600 billion more than President Obama is seeking from Congress.

Of course, not even the Republicans are proposing such a sweeping reform, which would certainly make the tax code more efficient — but also wipe out breaks for charitable giving and mortgage interest that enjoy wide red-state support, too. And the president himself has suggested limiting deductions in combination with rate increases, perhaps by capping the rate at which deductions may be claimed.

But because its impact is so heavily concentrated in blue states, the state and local deduction creates an asymmetry: Democrats have an extra reason to insist on raising rates, and Republicans have an extra incentive to demand loophole-cutting. Perhaps it’s just coincidence, but I have noticed that those most skeptical of the loophole-closing approach include Sen. Charles Schumer (D-N.Y.) and House Minority Leader Nancy Pelosi (D-Calif.).

So let’s all say a pre-Thanksgiving prayer for a successful negotiation — and remember that even a very grand bargain would still leave our state and federal tax and budget systems in need of major reform.

via Charles Lane: The best deduction to chop – The Washington Post.

Maxed out

As of yesterday, the federal government is officially maxed out on the  great national credit card.  We reached our credit limit of $14.294 trillion.   Government accountants think they can keep the bills paid using accounting tricks until August 2.   In the meantime, Congress needs to raise the debt ceiling.  Otherwise, the government could go into default.

Usually, raising the debt ceiling was more or less automatic, like passing resolutions celebrating Flag Day, but this time fiscal conservatives in Congress are threatening to keep that from happening unless the current administration agrees to major expenditure cuts.

Should Congress up the limit?  If it doesn’t, a default would surely be devastating for the economy, sending the dollar, government bonds, and foreign investment into a nosedive.  Would it be worth that to make a statement about out-of-control budget deficits?

President Obama’s deficit-reduction plan

It’s basically to raise taxes:

President Obama called for cutting the nation’s combined budget deficit by $4 trillion over the next 12 years on Wednesday, countering Republican budget plans with what he said was a more balanced approach that relies in part on tax increases for the wealthy as well as on spending cuts.

Mr. Obama spoke in strikingly partisan tones in parts of the 43-minute speech, offering a blistering critique of the Republican approach to reducing the deficit and laying down political markers that are sure to please even his most skeptical Democratic allies. The president vowed not to extend tax cuts for the wealthy or to dismantle the government-run health care systems for the elderly and poor. And he said there was “nothing serious or courageous” about the proposals Republicans offered this month.

Still, as he laid out the administration’s opening bid in negotiations over the nation’s fiscal future, Mr. Obama conceded a need to cut spending, rein in the growth of entitlement programs and close tax loopholes. At the same time, he insisted that the government must maintain what he called investment in programs that are necessary to compete globally. And he made clear that, despite his compromise with Congressional leaders in December, he would fight Republicans to end lowered tax rates for wealthy Americans that have been in place since President George W. Bush championed them in the last decade.

“There’s nothing serious about a plan that claims to reduce the deficit by spending a trillion dollars on tax cuts for millionaires and billionaires,” Mr. Obama said of budget proposals put forward by Republicans in the House. “There’s nothing courageous about asking for sacrifice from those who can least afford it and don’t have any clout on Capitol Hill. And this is not a vision of the America I know.”

In his remarks, delivered at George Washington University, Mr. Obama offered an impassioned defense of the popular Medicare and Medicaid programs against Republican proposals for sweeping changes in them. “We are a better country because of these commitments,” he said. “I’ll go further — we would not be a great country without those commitments.”

To the likely disappointment of some of his most liberal supporters, though, Mr. Obama signaled that he agreed with Republicans about the need to cut spending.

He acknowledged that some people would oppose cutting spending now, “mostly folks in my party,” the president said. “I’m sympathetic to this view, which is one of the reasons I supported the payroll tax cuts we passed in December. It’s also why we have to use a scalpel and not a machete to reduce the deficit.”

“But doing nothing on the deficit is just not an option,” he said.

Among his proposals is a “debt fail-safe” mechanism that would force lawmakers into much more severe action if the deficit has not contracted significantly by 2014.

The provision would impose across-the-board cuts on most government programs, officials said, adding that it was intended to provide an incentive to motivate potentially reluctant lawmakers to take difficult but necessary steps.

via Obama’s Deficit-Cutting Plan Balances Cuts With Tax Increases – NYTimes.com.

So do you think this approach will work?  Is this better than Paul Ryan’s plan?

On the Ryan plan

Charles Krauthhammer defends Paul Ryan’s budget plan, which Democrats are decrying in apocalyptic terms for the way it slashes the budget, even though that will not be enough to balance the budget until 2040!  That’s how bad our deficit is!

The conventional line of attack on Ryan’s plan is already taking shape: It cuts poverty programs and “privatizes” Medicare in order to cut taxes for the rich.

Major demagoguery on all three counts.

(1) The reforms of the poverty programs are meant to change an incentive structure that today perversely encourages states to inflate the number of dependents (because the states then get more “free” federal matching money) and also encourages individuals to stay on the dole. The 1996 welfare reform was similarly designed to reverse that entitlement’s powerful incentives to dependency. Ryan’s idea is to extend the same logic of rewarding work to the non-cash parts of the poverty program — from food stamps to public housing.

When you hear this being denounced as throwing the poor in the snow, remember that these same charges were hurled with equal fury in 1996. President Clinton’s own assistant health and human services secretary, Peter Edelman, resigned in protest, predicting that abolishing welfare would throw a million children into poverty. On the contrary. Within five years child poverty had declined by more than 2.5 million — one of the reasons the 1996 welfare reform is considered one of the social policy successes of our time.

(2) Critics are describing Ryan’s Medicare reform as privatization, a deliberately loaded term designed to instantly discredit the idea. Yet the idea is essentially to apply to all of Medicare the system under which Medicare Part D has been such a success: a guaranteed insurance subsidy. Thus instead of paying the health provider directly (fee-for-service), Medicare would give seniors about $15,000 of “premium support,” letting the recipient choose among a menu of approved health insurance plans.

Call this privatization if you like, but then would you call the Part D prescription benefit “privatized”? If so, there’s a lot to be said for it. Part D is both popular and successful. It actually beat its cost projections — a near miraculous exception to just about every health-care program known to man.

Under Ryan’s plan, everyone 55 and over is unaffected. Younger workers get the insurance subsidy starting in 2022. By eventually ending the current fee-for-service system that drives up demand and therefore prices, this reform is far more likely to ensure the survival of Medicare than the current near-insolvent system.

(3) The final charge — cutting taxes for the rich — is the most scurrilous. That would be the same as calling the Ronald Reagan-Bill Bradley 1986 tax reform “cutting taxes for the rich.” In fact, it was designed for revenue neutrality. It cut rates — and for everyone— by eliminating loopholes, including corrupt exemptions and economically counterproductive tax expenditures, to yield what is generally considered by left and right an extraordinarily successful piece of economic legislation.

Ryan’s plan is classic tax reform — which even Obama says the country needs: It broadens the tax base by eliminating loopholes that, in turn, provide the revenue for reducing rates. Tax reform is one of those rare public policies that produce social fairness and economic efficiency at the same time. For both corporate and individual taxes, Ryan’s plan performs the desperately needed task of cleaning out the myriad of accumulated cutouts and loopholes that have choked the tax code since 1986.

Ryan’s overall plan tilts at every windmill imaginable, including corporate welfare and agricultural subsidies. The only thing left out is Social Security. Which proves only that Ryan is not completely suicidal.

But the blueprint is brave and profoundly forward-looking. It seeks nothing less than to adapt the currently unsustainable welfare state to the demographic realities of the 21st century. Will it survive the inevitable barrage of mindless, election-driven, 30-second attack ads (see above)? Alternate question: Does Obama have half of Ryan’s courage?

via After Ryan’s leap, a rush of deficit demagoguery – The Washington Post.

Who won in the budget showdown?

The Republicans, according to this analysis, got the better of the budget negotiations:

HR1 was originally to seek spending cuts of $32 billion until Tea Party conservatives insisted on more than $ 60 billion. House Speaker John Boehner won more cuts than he originally sought and got the Senate to agree to votes to defund the health care reform law and groups like the nation’s largest abortion provider Planned Parenthood – once votes Senate Majority leader Harry Reid said he’d never allow to come to the floor.Back on February 3, Reid called $32 billion in cuts “extreme” and “draconian.”

At a news conference New York Sen. Chuck Schumer, D-N.Y., agreed, “I happen to think some of their cuts are extreme and go overboard. But every week they keep upping the ante and proposing extreme cuts.”

Over the next decade the cuts are expected to save hundreds of billions of dollars.

The deal mandates a host of studies and audits of Obama administration policies. It also blocks additional funds for the IRS sought by the Obama administration and bans federal funding of abortion in Washington, D.C.

The history of offers on this bill goes something like this. Democrats first offered no cuts, then $4 billion, then $6.5 billion, then $33 billion, then settled at $38.5 billion.

Boehner made numerous adjustments to his offer in recent days too, but started at $32 billion, then with a Tea Party push went to $62 billion, then dropped to $40 billion, then $38.5 billion.

Democrats claimed they met Republicans halfway after the $10 billion in cuts that already passed this year were approved. They settled late Friday night at three and a half times more.

Boehner came in $8.5 billion higher than the halfway point between his high offer of $61 billion in cuts and the Democrats opening bid of zero cuts.

via Who Won the Shutdown Showdown? It Wasn’t Even Close – FoxNews.com.


CLOSE | X

HIDE | X