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On the Fiscal Cliff, Republican Rebels are Right: No Deal is Better Than a Bad Deal

December 20, 2012

By Avik Roy

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Last night, House Speaker John Boehner (R., Ohio) pulled his "Plan B" off the House floor because it lacked support from the House Republican caucus. The media is atwitter about Boehner’s failure to control his troops, because they believe that President Obama has gained a tactical victory from it. But as a policy matter, it’s far better that Republicans pass nothing, than pass a tax increase without any accompanying reform of our runaway spending on health-care entitlements. Indeed, despite all of the dramatic hyperbole about the "fiscal cliff," it’s important to remember that going over the fiscal cliff will reduce the budget deficit by $503 billion in 2013, and $682 billion in 2014, relative to the "solutions" being bandied about on Capitol Hill. What’s so terrible about that?

First, let’s review the key components of what will happen in 2013 if Congress passes nothing this month.

Fiscal cliff component #1: Tax increases

The first aspect of the fiscal cliff is that taxes will go up. Income tax rates will revert back to the rates we had under President Clinton, leaving aside the additional $1.2 trillion in tax increases that Democrats passed under Obamacare. The top income tax rate will rise to 39.6 percent from 35 percent.

In addition, there are a number of other temporary tax provisions that will expire. Congress steps in every year to add an inflation adjustment to the Alternative Minimum Tax, because the AMT was not originally indexed to inflation. Without an inflation adjustment, more people will meet the income threshold for the AMT.

The deficit impact of extending these provisions, as people on both sides of the aisle want to do, is $330 billion in 2013, and $420 billion in 2014, according to the Congressional Budget Office.

If Congress were to extend all of these temporary tax provisions except for the lower tax rates on individuals with incomes above $200,000, as President Obama has advocated, the deficit impact would still be steep: $288 billion in 2013, and $382 billion in 2014.

Fiscal cliff component #2: Spending cuts

The second aspect of the fiscal cliff is that, if we go over it, spending will go down. Temporary payroll tax holidays, which reduce the Social Security and Medicare payroll taxes paid by employed individuals, will expire. In addition, the "temporary" extension of unemployment benefits undertaken during the recession will finally end. Continuing those temporary tax holidays and temporary unemployment benefits will increase the deficit by $108 billion in 2013, and $150 billion in 2014.

Importantly, Medicare’s Sustainable Growth Rate will take effect, reducing Medicare’s payments to physicians by tens of billions of dollars. This provision, and a few others, will reduce federal spending by $40 billion in 2013, and $61 billion in 2014.

In addition, the Budget Control Act—the law passed last year during the epic debt-ceiling fight—automatically sequesters, or reduces, defense spending by $24 billion in 2013 and $51 billion in 2014.

Fiscal consolidation is inevitable; if not now, when?

Adding all of that up—and understanding that the payroll tax holiday more closely resembles economically impotent stimulus spending—kicking the can down the road comes at a steep fiscal cost. Now, I’m not in favor of going back to the Clinton tax rates. I believe that we should keep tax rates where they are, and reduce spending to get rid of our budget deficit. But President Obama has promised to veto any bill that does so. So what should responsible politicians do?

Remember that continuing to spend money we don’t have isn’t free. Deficit spending is a tax increase on our children and our grandchildren, and on people who have done the responsible thing and built up their savings. Going over the cliff means that the accounting gimmicks are over. No more "temporary" this and "temporary" that, so that Congress can pretend to be more fiscally responsible than it’s actually being. Going over the cliff means that a broad swath of Americans will be required to pay for the enlarged government that they voted for in November. I don’t think that’s such a bad thing.

Much of the Republican behavior on Capitol Hill has been driven by fear of how the electorate will view Republicans if they don’t continue to pass temporary tax cuts. But reducing the deficit will have to happen sometime, and whenever it happens, it is likely to have some negative impact on the economy. If Republicans don’t want to reduce the deficit two years away from the next election, under a Democratic President and a Democratic Senate, they’ll never reduce the deficit. The time to reduce the deficit is now, before a real fiscal crisis emerges, one that makes Greece look like a picnic.

By leaving town and letting America go over the fiscal cliff, Republicans don’t have to vote for tax hikes that they justly oppose. Economically counterproductive spending, like the unemployment benefit extension, will come to an end. And an enormous amount of irresponsible accounting gimmickry, like the annual wrangling over the Medicare "doc fix," will end also.

And once Democrats gain their generational victory—returning to the Clinton-era tax rates—what case will they be able to make for even higher tax increases next year? Instead, the conversation will move back to what it always should have been about: the fact that the government spends too much taxpayer money, money it doesn’t have.

A responsible alternative to doing nothing

Now all of this is not to say that there wasn’t a better policy solution to be had. Raising Medicare’s retirement age is far preferable to drastically cutting physician reimbursements, and would save more money over the long term. Across-the-board defense cuts are far clumsier than letting the Secretary of Defense propose his own optimized version of the same amount of spending cuts. And Mitt Romney’s approach to tax reform—reducing loopholes and deductions in exchange for lower tax rates—would stimulate the economy and increase tax revenue.

Democrats have vowed to block such measures. But we can’t let the perfect be the enemy of the good. A package along these lines should have formed the basis for Speaker Boehner’s "Plan B," instead of the politically expedient tax hike he actually proposed, one that his own caucus could never support.

The key for Republicans is to also do the right thing in 2013. Democrats will come back in 2013 and attempt to pass all of their spending priorities, along with the Bush tax cuts for everyone making less than $200,000, and dare Republicans to oppose them. But Republicans should indeed oppose them, unless those tax cuts are accompanied by serious entitlement reform.

President Obama has insisted that he would be happy to go over the fiscal cliff in order to ensure that the wealthy pay more in taxes. The responsible thing for Republicans to do is to let him.

Original Source: http://www.forbes.com/sites/aroy/2012/12/20/on-the-fiscal-cliff-republican-rebels-are-right-no-deal-is-better-than-a-bad-deal/

 

 
 
 

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