Posts Tagged ‘fiscal cliff’

I agree with pretty much everything Marc has to say on the deal below. (For my own thoughts, see here.) Nevertheless, from a political point of view, something very like this deal was inevitable.

First, the Republicans held a bad hand. All the Bush tax cuts were going away, so they had very little leverage. The only leverage they had was over letting unemployment benefits, stimulus tax credits, and corporate welfare expire, and letting the sequester take effect immediately. However, Republicans are scarcely fonder of the sequester than are Democrats, both because of its cuts to defense and because of the blunt, across-the-board nature of the domestic discretionary cuts. As soon as the negotiations turned to dealing with taxation and spending separately, Republicans were never going to get significant spending cuts out of a taxation deal, because they had very little to offer Democrats on taxation. In the end, Republicans got a higher income threshold for tax increases, but paid for it with extensions of the foregoing expenditure programs.

Why were Republicans not willing to give a little more on tax increases on the rich in exchange for cuts in tax expenditures? Here the optics play a role. Pushing hard to let the low-income and higher ed tax credits expire could easily be demagogued. Letting extended unemployment benefits expire when Republicans continue to insist that the economy is weak would also be jarring. On the corporate welfare side, the diffuse-costs, concentrated-benefits logic applies in full force. Besides people who read sites like this one and the concentrated interests who benefit from such programs and spend literally hundreds of millions of dollars a session lobbying for them, no one cares about corporate welfare, and many even think of it as “pro-business” (as I’ve read journalists oh-so-neutrally describe them in articles on the deal) and therefore somehow pro-recovery.

Now, if this analysis is correct, then in two months when the spending side of the fiscal cliff is dealt with, Democrats will hold a similarly weak hand, and we should look for essentially zero Republican concessions on taxes. If the outcome deviates from this prediction in either direction, then we will have good reason to think that extraneous factors, such as “negotiation skills,” played some kind of role.(*) But I would look for the Nash Equilibrium to obtain.

(*) Another possibility, of course, is that I misread the (House) GOP’s preferences. They may hate defense spending cuts so much that they are willing to allow more tax increases to prevent them. That would, of course, be a perfectly awful outcome from a limited-government perspective — and therefore very much within the realm of possibility.

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The Fiscal Cliff Deal

This piece by Jamie Dupree is the best summary of the fiscal cliff deal I have seen. Read it and weep. Basically, the deal cuts taxes significantly (against the cliff baseline) and increases spending somewhat (if tax expenditures are counted as spending). The worst aspects of the bill are undoubtedly the one-year extensions of numerous corporate-welfare tax expenditures. The deal does nothing to reduce the large and growing federal structural deficit. The sequester is delayed by two months, which should result in another round of negotiations over replacing the sequester and adopting budget cuts to offset the increase in the debt ceiling that will have to take place by then.

From a traditional Republican perspective, the fiscal cliff deal is a good one, as it cuts taxes significantly. Of course, the traditional Republican perspective is wrong, because the only real tax cuts are spending cuts. Thus, from a limited-government perspective, the deal is a bad one, and the House should vote it down. Certainly, significant, immediate fiscal contraction is undesirable, but a better deal would give the Democrats more statutory tax increases in exchange for eliminating the extended tax expenditures and doing something, however small, about unsustainable entitlement spending. The pols should be sent back to the drawing board.

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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.

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