Driving off the fiscal cliff

As an historian who has spent nearly 40 years researching and writing about state finances, may I make a modest proposal?  Drive off the fiscal cliff.

Once out of Tax-Rate Fantasyland and back in the real world, we should apply a combination of well-established international criteria to our problems. Through the IMF and World Bank, we constantly insist that other countries adhere to the Washington Consensus principles.  Let us take the novel approach of emulating Chaucer’s parson: practice first, and then preach.  1) Honor sovereign debt; 2) get the deficit down below 3% of GDP (the same level now mandated by the European Union); and 3) in time, get the national debt back to 60% of GDP.

Why drive off the cliff?  First of all, it’s smart politics.  Presidential negotiation with the 112th Congress makes no sense. Pres. Obama should wait until the 113th Congress convenes, on January 3, 2013, to re-open negotiations.  Pres. Obama should simply announce that he has made good-faith efforts to bargain with the 112th Congress and those efforts have failed.  He will make his legislative proposals for 2013 to the 113th Congress.

Once the three special elections are held, the House will have 87 new members (20%) and the Senate 12.  Both bodies will have more Democrats.  Given that so many House Republicans elected in 2010 came into office on the basis of being inalterably opposed to any Obama policy, and given that Sen. McConnell publicly stated, in the aftermath of the 2010 midterm Republican landslide, that his party’s main goal was to defeat Pres. Obama in 2012, so that they could put the Republican agenda into place, why would Pres. Obama negotiate with the Republican members of the 112th Congress?  Their goal in negotiations – defeating his agenda and him – is no longer relevant, because the 2012 election is over.

Negotiate with people to whom you can offer some benefit:  that means the 113th Congress, not the 112th.

Second, to restore sound government finance, we actually do need to keep in place parts of the January 1 new deal.  Federal law will abolish the Bush tax cuts for everyone.  Negotiations with the 113th Congress would then have nothing to do with “raising” taxes, because the Clinton-era tax rates will be back in effect.

Pres. Obama  can announce that his first bill for the 113th Congress will be one that cuts tax rates for the bottom 98% of taxpayers (in 2011, <$360k).  Republicans can vote for such a bill without violating their no-new-tax pledge.  He must also announce, at the start, that he will veto any bill that includes cuts for those in the top 2%, but is willing to discuss their tax rates as part of the later negotiations over tax reform.

He can send a bill phasing back in the standard withholding rate: instead of jumping back to 6.2% in 2013, let it go to 5.2% in 2013 and 6.2% in 2014.  The full withholding increase takes $1,000 of net income out of the pockets of the average person paying SS withholding in 2013:  that’s a pretty hefty drop in net income (= – 0.67% in the GDP).  In the fragile recovery, it makes sense to reduce that impact by half.

The President can also send Congress bills to make other key changes:  1) Shift to percentiles and stop using actual $ figures – thus keep the higher tax rate for the top 2% of incomes, not for incomes over $360k.  As incomes go up, the system indexes itself.  2) Follow the Congressional Budget Office’s advice and use this technique for Social Security (SS) withholding.  When Pres. Reagan and Congress raised the rates to “save” SS in 1983, we were taking withholding from 91% of earned income:  they set the rates on that assumption. Now, because the highest income earners get so much more of the total income pie, and because we use fixed $ amounts ($110k in 2012), we withhold from only 85% of earned income.  Let us go back to the level on which Reagan and Congress set the current rate.  The missing 6% of income subject to withholding costs SS $45 billion a year.

He can send a bill to make the same change to the Alternative Minimum Tax (AMT): the original justification (1969) for such a measure mentioned 154 (sic) individual returns that prompted the change.  Ok, let’s make it simple:  1) pick a level, let’s say top 1%; 2) mandate a minimum tax on their adjusted gross income, say 25%; 3) allow them to shift charitable deductions [up to a 10% of their AGI] to page 1 of form 1040, in a special income adjustment area, so that charities do not suffer catastrophic financial hits.  That’s it: no complicated forms, no elaborate calculations, no special categories, nothing.  1, 2, 3:  we then get a minimum of 22.5% from everyone in the top 1%.  That’s a lot more than we got from Mitt Romney last year.

Pres. Obama can send legislation about de-politicizing the national debt ceiling:  it’s long past time for us to stop behaving like spoiled children.  Either Congress stands behind US Government debt or it does not.  We would never tolerate (through the IMF and World Bank) this sort of behavior from a Latin American or African country; we should not tolerate it at home, either.

To get back to the standard pattern of American government finances – a deficit of about 2% of GDP in the decades before Reagan’s tax cuts – we need to target income at 19% of GDP and expenses at 21% of GDP.   That’s a realistic goal for fiscal 2016.  Reducing the national debt back to 60% of GDP is realistically a job for our next President and the 115th Congress; to judge from the history of state finance world-wide, they will surely use inflation to do it.

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