[The
problem, as always, is that the two parties cannot agree on what changes should take place. The combination — of
political stalemate and potential economic cataclysm — will create an
extraordinary period after this year’s election. A lame-duck Congress and Mr.
Obama, either re-elected or defeated, will have less than two months to agree
on an alternative plan, or the tax increases and spending cuts will take effect.]
By David Leonhardt
The middle-class tax increase is just the beginning of
budget changes set to take effect at the start of 2013. Poor families would see
their taxes rise somewhat, too. Total federal taxes for top-earning families
would rise by tens or even hundreds of thousands of dollars a year. Spending
cuts would also take effect, squeezing domestic programs — education,
transportation, scientific research — and the military.
All in all, the end of 2012 will be unlike any other time
in memory for the federal government.
The tax increases
and spending cuts are
the result of Washington
Not surprisingly, leaders of both parties now say they are
opposed to letting the changes happen on Jan. 1. Economists are also frightened
of what such a sharp shift in government policy might do to a still fragile
economy. Ben S. Bernanke, the Federal Reserve chairman, has referred to the various expirations as “a
massive fiscal cliff.” Congressional aides, quoted in The Washington Post, call it “taxmageddon.”
The problem, as always, is that the two parties cannot
agree on what changes should take place. The combination — of
political stalemate and potential economic cataclysm — will create an
extraordinary period after this year’s election. A lame-duck Congress and Mr.
Obama, either re-elected or defeated, will have less than two months to agree
on an alternative plan, or the tax increases and spending cuts will take
effect.
Optimists — yes, there are still some — say that the
prospect of the tax hikes and cuts could finally
nudge the two parties
to the kind of deficit solution that many experts prefer. It involves sweeping
tax reform that would close loopholes, reduce marginal rates, simplify the tax
code and perhaps even lift long-term
economic growth. Such tax reform has always been easy to put off,
but the compromises it requires may end up being easier to accept than
taxmageddon.
YET there is still a basic contradiction with which most politicians
and voters have yet to grapple, the same contradiction that has helped create
this strange situation in the first place. Talking in exasperated tones about
the importance of fiscal responsibility is easy. Cutting the deficit is hard,
because it involves unpopular tax increases or unpopular spending cuts — and
huge cuts if the solution involves only spending, not taxes, as many
Republicans urge.
Either way, the changes will affect the vast majority of Americans, given
that the deficit reflects a basic disconnect between the government we have and
the taxes we are willing to pay. Social Security, Medicaid and Medicare may
become less generous. The Pentagon may no longer be able to get just about
whatever it wants. Taxes may have to rise from their recent levels, which have
been lower, as a share of the economy, than at any point in 60 years. That
could mean higher rates. Or, if tax reform actually happens, it could mean
smaller tax breaks for health care, housing and retirement savings.
The looming end of billions of dollars in popular
government benefits may seem ridiculous. And the fact that Washington
Nothing highlights the paradox quite like tax reform.
Most people seem to want tax reform. In a 2011 Pew Research
Center poll, 59 percent of respondents said the tax code was so
flawed that Congress should “completely change it.” President Obama and
Representative Paul Ryan, the architect of the Republican budget plan, each
claim to be more in favor of tax reform than the other one.
The notion of tax reform also has widespread support from
economists, liberal and conservative. As they define it, reform would reduce
marginal tax rates while eliminating or reducing various tax
breaks. The tax code would then be flatter and simpler. Individuals
and companies would not have to spend so much time and effort filling out their
tax returns and figuring out which provisions helped them — an especially
appealing notion this time of year.
Nobody knows for sure, but many economists believe that tax
reform could lift economic growth, by freeing people to spend and work in the
ways they think make the most sense, rather than in ways that happen to reduce
their tax bill. Mr. Ryan’s plan would cut the top rate to 25 percent,
from 35 percent, and still leave overall tax collection roughly where it has
been, by eliminating tax breaks.
What’s missing from these plans is any detail on which tax
breaks would be eliminated. Corporate lobbyists, like those at the Business
Roundtable, offer an especially
telling contrast: they urge the government to reform the tax code
while continuing to push for loopholes that benefit them and generally refusing
to name loopholes they would close.
The tax breaks that cost the government the most money turn
out to be overwhelmingly popular. The three largest are those for health insurance
provided by employers, mortgage interest and 401(k)’s. Corporate tax breaks are
smaller, but the biggest corporate breaks are often
popular, too, like the one for research and development.
“Tax reform is vital but difficult,” said Lawrence H.
Summers, the former economic adviser to Mr. Obama and President Bill Clinton.
“When people think of tax expenditures, they think of standing up to the oil
industry. But a ton of it is things like I.R.A.’s.”
He added: “The moment you start to look at the expenditures
you’d eliminate, you’re struck by how much pain there is for modest rate
reductions.”
Optimists who believe tax reform could happen look to 1986, when
President Ronald Reagan and a bipartisan Congress lowered rates and eliminated
loopholes. However, there are at least two major differences between then and
now. Most of the loophole closing in 1986 affected companies, not individuals.
And policy makers spent months and months working together to put the law
together.
None of that will be possible in the eight weeks between
Election Day 2012 and Jan. 1, 2013 .
“Tax reform is a process, not an event,” saidDonald Marron,
a former aide to President George W. Bush who now runs the Tax Policy Center Washington
What, then, will happen later this year?
Much will depend on who wins the presidential election.
(Neither party is likely to have a filibuster-proof majority in the Senate.) If
Mr. Obama wins re-election, he and his aides say, he will not extend all the
Bush tax cuts, as they agreed to do in 2010.
They instead plan to insist on a deficit plan that combines
spending cuts with higher taxes for the affluent, who have received the largest
tax cuts in recent decades. Mr. Obama, according to a senior adviser speaking
last week, views taxmageddon as a chance to force the Republicans to
acknowledge that even they do not support the spending cuts necessary to
balance the budget without tax increases on the wealthy.
For the White House, the best case might pair an extension
of the Bush tax cuts for several more months with a legislative framework for a
new tax code that reduces tax breaks for the affluent. The top rate might not
rise, but taxes on the rich would. Policy makers would work out the details in
early 2013.
The so-called Buffett Rule, a focus of Mr.
Obama’s last week, is a model for such a tax system. It does not
specify which tax breaks would shrink for households with more than $1 million
in income but rather caps the total value of such tax breaks. Martin Feldstein,
a Republican economist, has proposed a similar cap for all taxpayers. The
approach is meant to avoid a political war of attrition over every large,
popular tax break.
Of course, Republicans have shown scant sign of wanting to
compromise on high-end taxes, even after election losses, as in 2008. If they
hold firm once again, Mr. Obama will have to choose between standing down (once
again) and allowing taxes to rise on every household when the economy is still
likely to be weakened.
Complete gridlock will include not only the expiration of
the Bush tax cuts and the payroll-tax cut from the Obama stimulus but also a
sharp increase in the Alternative Minimum Tax and cuts to national-security and
domestic programs, prompted by Congress’s failure of last summer to reach a
deficit deal. Together, the changes would reduce the deficit by more than 60
percent in the 2014 fiscal year, according tothe
Congressional Budget Office, but would inflict obvious pain.
With Mitt Romney in the White House and a Republican House,
the uncertainty might be less. Unless Congressional Republicans and a defeated
Mr. Obama somehow came to a deal, they could wait for him to leave town before
retroactively extending the Bush tax cuts, so long as they could win over a
small number of Democratic senators. Republicans could likewise undo the
Pentagon cuts.
To hold down the deficit, Mr. Romney and Congress could
then cut domestic programs, including Medicaid, more sharply than Mr. Obama
has. But recent history — both Mr. Reagan’s administration and the second Mr.
Bush’s — suggests that Republicans would probably not find enough spending cuts
to offset their tax cuts and instead would accept larger deficits.
In the short term, it might not matter. The deficit is
falling already, as the economy slowly emerges from the financial crisis, and
foreigners remain happy to lend money to Washington
Eventually, though, the deficit will start growing again,
and sharply. The baby boomers are retiring, and health care is getting only
more expensive. The era of falling taxes and growing benefits cannot last
forever. The fiscal chaos that awaits at the end of this year is a preview of
the choices to come.
