averting the ‘fiscal cliff’

On January 1st the United States reaches the so-called “fiscal cliff“: automatic tax increases and defence spending cuts that Republicans loath, as well as other spending cuts that Democrats find offensive. These automatic fiscal changes will most certainly plunge the US (and the world) into another recession. They can be averted only if Republicans and Democrats in Congress make a deal on the budget, and increased tax revenue will have to be part of any deal.

Harvard economist Greg Mankiw (a Republican) and Berkeley economist Christina Romer (a Democrat) suggest ways that Republicans can agree to increase tax revenue without violating pledges of “no new taxes”.

According to the Tax Policy Center, if we cap itemized deductions at $50,000 and keep tax rates as they are today, we would raise $749 billion in tax revenue over ten years [about $75 billion a year].  Moreover, according to the TPC’s distribution table, 96.2 percent of the extra revenue would come from the top quintile, with 79.9 percent from the top one percent.

This may be the germ of a possible deal between President Obama and Speaker Boehner: The speaker agrees to this tax hike if the president agrees to some fundamental reform of the entitlements, such as gradually but significantly raising the age of eligibility for Social Security and Medicare.

Greg Mankiw, “How To Raise Tax Revenue From The Rich Without Increasing Tax Rates“, Greg Mankiw’s Blog, 10 November 2012.

A brief fall off the cliff would free lawmakers from the straitjacket of having signed Grover Norquist’s pledge never to raise taxes. Once taxes have returned to their Clinton-era levels, a partial reinstatement of the Bush tax cuts would count as a tax cut. And a brief plunge would also show that the president is serious about raising additional revenue. ….

Democrats should be flexible, however, about the form of tax increases. If Republicans want to cut exemptions and loopholes more and raise marginal rates less, that should be on the table. What shouldn’t be contemplated is redistributing tax burdens away from the wealthy and toward the middle class. And the additional revenue needs to be substantial. The Bowles-Simpson proposal that revenue be about $200 billion a year higher should be a guidepost for the size of a sensible tax component.

Christina D. Romer, “Economic View: Budget Showdown Offers an Opportunity for Progress“, New York Times, 11 November 2012.


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