U.S.

David Paul: Just Do It: A 10-Point Solution for the Fiscal Cliff

November 17, 2012

Our Congressional leaders all look like they have been fed castor oil, as they stand together trying to assure the nation that they will not let us go over the fiscal cliff. Nancy Pelosi summed up the sense of disconnect when she suggested that by Christmas, they should have a plan with clear timelines.

By Christmas? So they will have a plan by Christmas and it will be in place by New Years? I guess it is time to let the Pelosi grandkids know that the ski trip is off.

This should not be so hard. The fiscal cliff is nothing more than one more set of self-imposed deadlines that Congress put in place so that they could comply with their own rules. We have seen this before.

Gramm-Rudman-Hollins. Paygo. All sorts of rules that Congress tried to put on itself. Oh, yes, and the Bush tax cuts, that are the cause of all of this durm und strang. Those tax cuts did not have to expire. Congress could have made them permanent at the time. But Congressional spending rules would not allow permanent tax cuts without Congress admitting to the public that it was breaking the bank. So — unwilling to face up to its own profligacy — Congress squeezed those tax cuts between the cracks by pretending that they would pay for themselves in the out-years after they expired.

But even as they were passing tax cuts with an expiration date to comply with their own rules, Republicans at the time boldly pronounced that they would fight to extend the tax cuts when they were scheduled to expire, and pillory Democrats for wanting to raise taxes if they tried to let them expire. And so they have. Even for Washington, D.C., it has been a tour de force of political cynicism.

One way out of the current impasse — and I say impasse based upon the look on Mitch McConnell’s face as he tried to utter the words “I will play nice,” even as he imagined the beating he could get back home in Kentucky in two years when Rand Paul runs someone against him from the right — would be for Congress and the president to let go of their narrow objectives — just for a moment — and imagine what a collective package of changes might look like if they thought about the combined impact of the changes.

So, in the hope of getting Nancy onto the slopes with her grandkids after Christmas, and alleviating Mitch’s evident distress, I offer the following package of reforms as a recommended starting point. Keep in mind that each side has constituents and the package as a whole has something for everyone. This is not rocket science, it is — as Bill Clinton would say — arithmetic.

1. Begin with the premise that the 2001 and 2003 Bush tax cuts have expired, as will happen soon in any event if Harry Reid and Mitch McConnell cannot get their mutual loathing under control. So the top tax rate is back up to 39 percent, capital gains taxes and dividends are taxed as ordinary income and the carried interest exemption introduced in 2003 is history. Income derived from labor and capital is taxed equally, and at a high rate. Calm down Republicans. Remember this is the starting point.

2. Because of these changes, tax rates would be increased by at least 10 percent for most people, and by an extraordinary amount for people like Mitt Romney who have just enjoyed a ten year tax holiday that was never envisioned under the Reagan-era tax structure.

3. Introduce a cap on deductions as Mitt Romney suggested. A nice idea that prevents the need to eliminate any of the high-value deductions that each have strong lobbies supporting them and achieves the outcome preferred by Democrats of raising new revenue from the highest income earners, while Republicans would appreciate the fact that this reform would fall heaviest on high-tax, blue state voters. Based upon Tax Policy Center estimates, a $25,000 cap would raise over $1 trillion of new revenue, with 50 percent of that revenue coming from the top 1% of income earners. Combining the cap with an inflation adjustment would allow for the elimination of the AMT, an historically troublesome tax provision that was designed to have a similar effect.

4. You now have a far more progressive tax structure, theoretically producing significantly more income. So from that point cut nominal tax rates back across the board to a level that makes these changes revenue neutral. So far, we have accomplished two goals. We have reduced rates and we have increased the share of income paid by the top 2 percent.

5. To mollify the finance industry — and as the largest political contributors to Democrats and Republicans alike they have to be mollified — because of the elimination of the carried interest loophole and preferential treatment of investment income, we will modify Dodd-Frank — an enormously burdensome law that is killing small banks and financial entrepreneurship — essentially to have it apply only to those large firms that exceed a certain level of market share, such as 2 percent of consumer deposits or 2 percent of derivatives volume. The objective is to reverse the course of financial reforms that have been far too sweeping and instead refocus on the need to impose rigorous capital and regulator requirements on those firms that constitute systemic risks, while leaving others alone. Republicans will like this because it would reduce the regulatory burden on 99.5 percent of banks. Democrats will like this because it would focus regulatory efforts on the largest and most visible institutions and could ultimately induce stockholders to push for the breakup of larger institutions, which should be an objective in any case.

6. As dividends become treated as ordinary income, corporate tax rules should be changed to eliminate the double taxation of dividends. Eliminating the double taxation of dividends is an important step, but one that always should have been addressed at the corporate level rather than at the investor level. Democrats will scream, but this is the right thing to do to treat dividends on an equal footing with interest. I know, you have no idea what I am talking about, but suffice it to say that our recurring problem with corporate over-leveraging — dating back to the Michael Milken-era and up to the 2008 financial crisis — has been consistently supported by a federal tax code that incentivizes the use of debt over equity in corporate capitalization.

7. And as long as Democrats are screaming, raise the estate tax threshold back up to a high level. Pick a number. $10 million? $20 million? Whatever. The point is that wealth should be taxed when it is earned, and the estate tax is an ineffective tool for wealth redistribution. It might feel good, but at the end of the day it does little more than that. Our objective should be to fix our fiscal problems, and then have the capacity to focus on ways to assure upward mobility and access to education as our way of leveling the playing field. Just look at the Bureau of Labor Statistics data, the unemployment rate for those with a bachelors degree is 3.8 percent; for those with some college or an associates degree it is 6.9 percent; for those with a high school degree it is 8.4 percent; and for those who did not make it out of high school it is 12.2 percent. Education and enhanced social mobility is essential to addressing income inequality, and the estate tax is simply a punitive palliative.

8. While the increase in the estate tax threshold would ease a burden on the wealthy, the next step takes back what was giveth. It is time to establish means-tested co-payments for Medicare. It is simply the right thing to do. As the data shows, Americans by and large pay for their social security benefits, and thus means testing is not necessarily equitable. On the other hand, Medicare contributions over one’s lifetime pay only a fraction of the program cost. As such — and despite the illusion of many that Medicare is something they earned — Medicare is a general welfare program and it is reasonable and appropriate to skew the benefits on the basis of need.

9. This gets us to the payroll tax. That needs to remain in place. Washington must not continue down the road with the illusion of “pension holidays.” If you want to give money to people to spend, have at it, that is what Washington does best. But the payroll tax pays for our social security and it is in everyone’s interest to maintain the integrity of that system.

10. Finally, institute a carbon tax as a source of new revenue, and reduce income tax rates by one dollar for every two dollars raised. It is good public policy that Republican and Democrat economists can agree on.

The rest is just about jiggering the numbers to balance the costs and the benefits, but the pieces are there. Oh, yes, one more thing. The debt ceiling. It is time for a new law that ties budget approval to debt authorization. When Congress approves spending, it approves funding. There should be no disconnect between those two actions. There is no greater hypocrisy than listening to members of Congress who vote for spending and who vote for war and then turn around and pontificate about deficits and the debt ceiling. Time to end that charade.

So there it is. Crunch the numbers, run the traps, it works. For the president and Democrats, it increases the burden on the top 2 percent, and even within that cohort it is progressive. For Republicans, it reduces income tax rates, probably by at least 20 percent, and tackles our highest-cost entitlement. And for the country, it taxes things we don’t want, while reducing the taxes and regulatory burdens on things we do want. It reduces the incentives to over-leveraging in the corporate sector and to concentration in the financial sector. There is something there for progressives, environmentalists, corporate America, and for a broad swath of the financial sector.

Hedge fund managers will not be happy, but they are rich, so they will get over it. Mitt Romney just told them they lost because Barack Obama gave things to everyone else but them. Now Nancy and Mitch and Harry get to do the same thing.

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