Fiscal Cliff Follies (Note to GOP: Every Spending Cut is a Tax Cut)

This is not helpful. Erick Erickson, a man of excessive influence among conservative Republicans, is pressing Republican Speaker John Boehner to take any increase in tax rates off the table in the fiscal cliff negotiations with Democratic President Barack Obama. This is unhelpful for two reasons. First, rates will go up anyway if a deal isn’t reached, and Obama has made clear that some increase in rates is a deal-breaker. Second, every spending cut is a tax cut in the long run! The GOP should be willing, if necessary, to allow statutory tax increases, including rate increases, if they can get credible, significant spending cuts. By “credible” I mean cuts that will take effect automatically in the medium term (2-3 years from now), that are specific, and that will be difficult for Congress to overturn.

Everyone knows rates will go up eventually anyway. The US fiscal path is unsustainable. Whatever the government spends now it will have to pay back with tax dollars. Certainly, real interest rates on federal bonds are low or negative now, but that is a result of turbulence in Europe and slow growth at home. That situation won’t last forever. Large, immediate spending cuts are undesirable because the economy is still soft, but we really cannot be sure that we are not at or near the peak of the business cycle. The last recession started five years ago, and NGDP growth has puttered along at about 4% over the last two years. So spending cuts two to three years from now seem desirable.

How the tax code affects the productivity of the economy does not have very much to do with the average rate of taxation specified by statute, but the distortions brought about in the tax code (and poverty relief programs). Very high marginal rates of taxation can indeed kneecap labor supplymost of this type of distortion actually affects those with incomes under 200% of the federal poverty level. And of course, the corporate income tax code is riddled with distortionary tax expenditures (credits and deductions); getting rid of those is a free lunch: more revenue, more productivity.

Should Republicans use marginal tax rates on the wealthy as a bargaining chip to get bigger spending cuts? Of course. But that means keeping them on the table.

7 thoughts on “Fiscal Cliff Follies (Note to GOP: Every Spending Cut is a Tax Cut)

  1. You don’t really believe that agreeing to the rate increases Obama wants now will cause him and the Democrats to commit to some unnamed spending cuts to be negotiated later, do you?

    Raising rates on the “wealthy” will have little to no affect on the economy and the deficit. Do it or not, it is a political move that is popular, and the Republicans lose, politically, either way. If I were John Boehner I would immediately introduce a simple bill to raise the tax rates as Obama has requested – no more, no less – and then look him in the eye when he signs it and say “what now?”.

    1. Any rate increases should be part of a bill that also includes specific, credible spending cuts, as I say above.

      1. But Obama will never agree to them, as he has said with one of his ‘let me be clear’ speeches, he wants the rate increase, period. In fact his offer, as presented by Geithner, includes spending increases.

      2. Hahaha, I truly hope you are correct. Unfortunately he is a terrible negotiator, but we’ll see. I do think he has a lot to lose, in terms of his legacy, if he fails to strike a deal that includes a serious improvement on the country’s finances, and I think he loses if no deal is struck and we leap off the cliff.

  2. As always, a very reasonable and well argued post Mr. Sorens. I know it’s very easy to portray Obama as this anti-Rich bogeyman, but he is not as inflexible as he seems. Rising rates on the wealthy are more of a symbolic victory to the Democrats than an actual policy tool.

    I also find it a bit ironic that the offer Boehner made is exactly identical to the one Obama agreed to when his back was against the wall in 2011. They chose to go long on the play, rescinding that offer in hopes of an Obama defeat, but that seems to have missed. Their bargaining advantage is way dimished. The harder of a line they take the less they will ultimately get.

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