Fiscal Cliff: A Solution
Its not enough to talk about the fiscal cliff. The real question is… what can be done about it?
Fiscal cliff specifics are clearly defined. That makes finding a solution surprisingly straightforward; just apply one simple axiom… make ALL the politicians winners!
To define a solution it is first necessary to understand the problem, what it means and why it is happening now.
In order of need, this nation faces many major issues:
- Short-term fiscal cliff
- Long-term entitlement debt
- Tax Reform
U.S. Congressmen and Senators should remind themselves that, though related, they are different problems that require different solutions. There is no silver bullet. Don’t try to make one size fit all. That is hard. Make things easy. Take one at a time. Be a winner!
First, solve the short-term fiscal cliff problem. Then, early next session, legislate for job creation and finally move on to entitlement and tax reform to address long-term debt.
The fiscal cliff effect that needs fixing is preventing a short-term, half-year recession. Left alone, the CBO says GDP will drop -1.3% initially because of the weak economy, but then bounce back to +3.1% growth in the 2nd half of next year.
Why is there a Fiscal Cliff Now?
To define a proper fiscal cliff solution, it is helpful to briefly review how it came about.
A perfect storm of Congressional decision-making over the last 11 years has fused together to create this self-made crisis.
It all began with an artificial time limit put on the Bush-era tax cuts of 2001 and 2003. They were scheduled to end in 2010, but got extended for two years in late 2010 as economic stimulus to fight the Great Recession.
Another recession fighting stimulus measure is the Payroll Tax Holiday. Payroll taxes pay for Social Security. In a slightly different form it was started as part of the 2009 “Stimulus” package. A 1-year extension was created in late 2010 and then extended again through 2012.
Next comes the perennial Alternative Minimum Tax. Its purpose is to make sure the wealthy will always pay some taxes. Raising the minimum is an annual problem that must be fixed by Congress. Its nothing new.
Then there are a serious of other lesser tax hikes.
The other crucial part of the fiscal cliff are spending cuts that begin in January. They are “across the board” federal government spending cuts to last for 10 years.
The spending cuts are partial payment for granting the federal government $2.1 trillion more in spending authority back in 2011.
Fiscal Cliff Numbers to Work With
On the tax increase side next year it can be broken down into 4 chunks:
- Bush-era Tax Cuts ($166 billion)
- Payroll Tax Holiday ($125 billion)
- Alternative Minimum Tax ($119 Billion)
- Other less costly tax hikes ($62 billion)
- Obamacare ($23 billion)
- Remnants of the 2009 “Stimulus” ($21 billion)
- Tax Extenders ($20 billion)
- Death Tax ($13 billion)
- Business Investment Expensing ($8 billion)
On the spending cut side:
- Federal spending cuts ($110 billion)
- Defense ($55 billion)
- Other Discretionary ($55 billion)
The main difference between the tax hikes and the spending cuts are that the tax hikes are permanent; the spending cuts are temporary. The cuts are for $1.2 trillion in “across the board” spending cuts spread over 10 years. They were created as partial payment for authorizing $2.1 trillion more in federal deficit spending.
The most important question of all is this, “What is the proper mix of tax hikes and spending cuts that reduces the chance of recession?” Fiscal cliff tax hikes are less than half the $1.1 trillion federal deficit. No amount of tax hikes from anywhere can fix that, but it is also an immediate concern.
Everyone must feel a pinch. The best that can be done is to reduce the tax hikes enough to lessen short-term recession effects, yet raise revenues enough to slow down deficit growth a little.
Soo… make the President a winner. Give him tax hikes. Make Republicans winners. Give them spending cuts.
A reasonable starting point often suggested in Congress is a middle of the road $1 in tax increases for every $3 in spending cuts. That ratio comes from huge deficits and a $16 trillion national debt.
Here we go…
First, the Alternative Minimum Tax, a pure tax increase, has got to be eliminated by raising the minimum. Easy as pie. Compared to right now, it would have no net change to anyone, so no economic impact.
Second, nobody wants Social Security to go broke. So, the Payroll Tax Holiday has got to go to. Social Security is paid for by payroll taxes. It must be saved.
Right off the bat, $244 billion in fiscal cliff tax hikes, more than half the $494 billion total, are “fixed”.
Be generous. Give President Obama and Democrats some bragging rights for next year:
- Tax rate increase for everyone earning $250,000 or more ($50 billion)
- Obamacare taxes ($23 billion)
- The last remaining 2009 “stimulus” spending ($21 billion)
That gives President Obama $94 billion in tax hikes for next year.
In order to get to $3 in cuts for $1 in tax increases then there should be $282 billion in spending cuts next year.
Be generous. Give John Boehner and Republicans spending cut bragging rights for next year:
- Bush-era tax cuts for the middle class ($116 billion)
- Sequestration ($110 billion)
- Tax Extenders, Death Tax, Expensing for business investment ($41 billion)
- $3 in spending cuts for every $1 in tax hikes
Add them up and it comes to $267 billion.
The sequestration impact is logically minimized if Congress didn’t allow exemptions, like for Social Security, or other entitlements. That would give Republicans a very nice little victory claim since it starts the process of entitlement reform.
It doesn’t quite get there but is close to $3 in spending cuts for $1 in tax hikes. How about that!?
This solution achieves several important goals:
- Reduces the chance of recession
- Republicans get nearly $3 in spending cuts for every $1 in tax hikes
- President Obama gets the $250K tax hike
- Restores Social Security sanity
Most of the tax hikes on the middle class are counteracted by corresponding tax cuts in other areas (except social security) thus minimizing the chance for recession in the overall economy. That is the whole idea.
Social Security revenues, though, are well below expenditures so we must return to full contributions to keep it solvent. Making Bush-era tax cuts permanent and adjusting the AMT softens the middle-class blow.
Most remaining economic drag comes from sequestration. That impact is greatly minimized if Congress didn’t allow exemptions, like Social Security. That would give Republicans a nice little victory claim.
$110 billion is sequestration cuts sounds like a lot, but is only 3% of 2012’s federal budget and 5% of total federal revenues.
The federal government could absorb most of those cuts with minimal economic impact on government jobs and services. Efficiency improvements alone would probably account for most of the change. Few taxpayers believe the federal government runs so efficiently that there isn’t 3% fat that couldn’t easily be trimmed.
Every politician could then claim victory in important parts of the fix.
Make no mistake, short term GDP loss will occur in any fiscally responsible plan. Jobs will be lost. But with this solution a recession is avoidable.