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The Sticking Point on Taxes Gets Less Sticky

November 26th, 2012 . by economistmom

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Lori Montgomery’s front page story in today’s Washington Post sounds like a downer, entitled (in the print edition) “Taxes still the big ‘cliff’ hang-up.” Indeed, really since the George W. Bush Administration it’s always been differences over tax policy that have prevented policymakers from coming up with a bipartisan approach to deficit reduction.  (The bipartisan “compromises” have always been deficit increasing–a result of mutual “grabbing” instead of the mutual sacrifice that’s needed.)  Lori reports:

For the first time in decades, a bipartisan consensus has emerged in Washington to raise taxes. But negotiators working to avert the year-end “fiscal cliff” remain far apart on crucial details, including how taxes should go up and who should pay more.

Neither side gave ground in an opening round of staff-level talks last week at the Capitol. As President Obama and congressional leaders prepare for a second face-to-face meeting as soon as this week, the divide over taxes presents the biggest obstacle to replacing the heap of abrupt tax hikes and spending cuts, set to hit in January, with a less-traumatic debt-reduction plan.

People in both parties are exploring ideas for bridging the gap. Without a deal on taxes, there is not much hope for agreement on a broader strategy for restraining the national debt that also tackles the skyrocketing cost of federal retirement programs such as Social Security and Medicare.

But with tax rates set to rise automatically in January when the George W. Bush-era tax cuts expire, Democrats say they have little incentive before then to cut a deal that falls short of their revenue goals. That means going over the cliff, at least for a short time, remains a possibility, they say.

The long-standing impasse on tax policy has basically boiled down to this: Democrats want more revenue, raised entirely from households with incomes over $250,000.  Republicans don’t want any new revenue, and especially not from higher tax rates on the rich.  It seems like an irreconcilable difference.

But if you turn the front page of the post over, there on the very next page (A2) is a story by Sean Sullivan called (in print) “Two in GOP: ‘Cliff” deal worth defying Norquist” where we learn that:

A pair of congressional Republicans reiterated their willingness Sunday to violate an anti-tax pledge in order to strike a deal on the “fiscal cliff,” echoing Sen. Saxby Chambliss, the Georgia Republican who suggested last week that the oath may be outdated.

Sen. Lindsey O. Graham (R-S.C.) said he was prepared to set aside Grover Norquist’s Taxpayer Protection Pledge if Democrats will make an effort to reform entitlements, and Rep. Peter T. King (R-N.Y.) suggested the pledge may be out of step in the present economy.

“I agree with Grover — we shouldn’t raise rates — but I think Grover is wrong when it comes to we can’t cap deductions and buy down debt,” Graham said on ABC’s “This Week With George Stephanopoulos.”…

Last week, Chambliss drew attention when said he was willing to buck Norquist’s pledge. “I care more about my country than I do about a 20-year-old pledge,” Chambliss told WMAZ-TV of Macon, Ga. “If we do it his way then we’ll continue in debt, and I just have a disagreement with him about that.”

King echoed Chambliss’s assessment Sunday. He said that while he opposes tax increases, he does not advocate taking “ironclad positions” during the negotiations between Democrats and Republicans on the nation’s fiscal issues.

In other words, many Republicans aren’t so enamored with Grover’s “no new taxes” pledge these days, because they don’t agree with the “no new revenue” interpretation.  These Republicans recognize the economic difference between raising revenue by raising marginal tax rates, and raising revenue by broadening the tax base and reducing “tax expenditures”–the subsidies in the tax code.  The former increases the size and influence of government; the latter reduces it.

For any Republican who feels the same way that Chambliss, Graham, and King do, the common ground they share with the Obama Administration on tax policy and deficit reduction is actually very large.  In every one of President Obama’s budgets, he has proposed to limit itemized deductions to the 28 percent rate, which has the effect of reducing (not eliminating) the value of deductions taken by households above the 28 percent income tax bracket (who happen to be, not surprisingly, those households with incomes above $250,000), such that those households just can’t get a larger subsidy on any given dollar value of activity (mortgage interest, charitable donations, etc.) than households with lower incomes would get.  It seems to make “eminent” sense (among economists at least) to eliminate or at least reduce the “upside down” nature of tax subsidies this way.  Only because tax expenditures are subsidies brought over to the tax side of the ledger, do we have so many government subsidies that are more generous the higher one’s income.

This year’s version of the President’s proposal to limit tax expenditures for higher-income households raises $500 to $600 billion over ten years.  (The Obama Administration said $584 billion; the Congressional Budget Office said $523 billion.)  That amount is higher than it has been in past years, because this year the Administration broadened the proposal to not just limit itemized deductions, but also limit the value of certain tax exclusions, including the exclusion of employer provided health insurance.  (As explained in the President’s budget (page 39):  “This limit would apply to: all itemized deductions; foreign excluded income; tax-exempt interest; employer sponsored health insurance; retirement contributions; and selected above-the-line deductions.”)  Still, that only covers about one-fourth of the $2 trillion+ cost of extending even only the “middle-class” portions of the Bush tax cuts, a tax policy President Obama also proposes in his budget.  For years CBO has scored a more aggressive version of the President’s limit on itemized deductions–one where they would be limited to the 15 percent bracket.  This would raise more than a trillion dollars over ten years ($1.2 trillion in CBO’s March 2011 report)–enough to cover a bit over half the cost of the extended tax cuts, even without extending these limits to the exclusions.

Well, now you can see how the math of base-broadening tax reform works: the more one is willing to broaden the tax base and limit or eliminate certain tax expenditures, the more one can “buy” extended lower tax rates.  If significant-enough base broadening is too hard to do (politically or economically) to achieve a certain revenue goal, then rates will have to come up to at least somewhere in between current policy and current law (with all tax cuts expired).  Both Republicans and Democrats seem to like this general principle of substituting a broader base for lower rates, and even the particular combination of limits on itemized deductions paired with continued, low marginal tax rates for most Americans.  The details as to what extent deductions and exemptions will be capped or limited, and which households would be affected, and (therefore) which tax rates would be kept how low, are the specific points that should be the focus of bipartisan negotiations on this sticking point called tax policy–if policymakers indeed want to get around to agreeing on policy.  (What to do about preferential capital gains and dividend tax rates is another huge issue to work out in this base-vs.-rate tradeoff, and makes a huge difference in terms of both revenue and distributional effects.)

But it certainly doesn’t seem to help for Republicans and Democrats to keep emphasizing the tax policies they would each choose to implement if they were “king of the world” –for example, Democrats insisting that tax rates on the rich must come up to pre-2001 levels or even higher, while Republicans keep arguing for just the opposite.  Refer again to the Lori Montgomery story, where she explains (and note my added emphasis on the polling question):

For now, Democrats are seeking $1.6 trillion in new taxes over the next decade collected from about 3 million families at the pinnacle of the income spectrum — those earning more than $250,000 a year. The Democrats want to start by letting the top two tax rates return to 36 percent and 39.6 percent when the Bush tax cuts expire.

Republicans insist on maintaining the Bush rates, at 33 percent and 35 percent, through 2013. Instead, they want to raise cash by rewriting the tax code to eliminate individual loopholes and deductions, an approach House Speaker John A. Boehner (R-Ohio) argues would be less harmful to businesses and the economy.

It is also more popular, Republicans say. They pointed to a new poll by the Winston Group, a GOP research firm whose president, David Winston, is close to Boehner. Sixty-five percent of those surveyed preferred a deal that wipes out “special interest tax loopholes and deductions commonly used by the wealthy” over an approach that raises tax rates on “Americans earning more than $250,000” on Jan. 1.

GOP negotiators have declined to say how much they are willing to raise, according to people familiar with the talks. In the past, Boehner has proposed $800 billion. But who, in the Republicans’ view, should foot that bill is unclear.

The preoccupation with this particular line in the sand (”tax the rich!”–”no, don’t tax the rich!”) detracts from the broader areas of agreement on the base-broadening approaches, as well as the tax-policy reckoning ultimately facing all politicians and all of us: that tax burdens will probably have to come up on almost everyone, far from the “almost no one” fantasy tax policy world we’ve been stuck in.  (”Wait, who are the rich?!”)  We could get closer to a real-world view of tax policy, and to a successful, productive, bipartisan resolution of both the “fiscal cliff” issue and our longer-term fiscal challenges, if our politicians can lead the people this time–rather than be led by the polls that can’t possibly ask the right questions–and focus on the basic and essential math on tax policy that has got to be worked through immediately and for awhile to come.  The groundwork of bipartisan tax policy ideas is already there though; they just have to stop bickering from the corners and step onto that common ground.

Some of this common groundwork has to be done right away in the negotiations over what to do about the fiscal cliff–which is just the first installment of tough choices regarding the entire future path of the federal budget.  Ultimately for the larger and longer-term deficit reduction goal, however, it’s not just that more Republicans will have to break up with Grover over the “no new taxes” pledge in order to do smart tax reform, but that more Democrats will have to be willing to consider reforms to Social Security and the health programs (Medicare/Medicaid) that, as Lindsey Graham has recently put it, should be considered “eminently reasonable.”

7 Responses to “The Sticking Point on Taxes Gets Less Sticky”

  1. comment number 1 by: Brooks / Gordon

    Krugman, in addition to his typical blatant hypocrisy and obvious straw men, apparently claims that we have no reason to worry about deficits and growing debt, because we can just print as much money as we want, without negative consequences — in fact, with all very positive consequences. http://www.nytimes.com/2012/11/26/opinion/krugman-fighting-fiscal-phantoms.html?_r=0

    All gain, no pain! Wow, what a difference a decade makes for some people http://blog.scrivener.net/2009/08/krugman-versus-krugman-on-deficits-and.html

  2. comment number 2 by: Vivian Darkbloom

    Yep, that’s Klassic Krugman:

    “If you ask me, it’s time for Washington to stop worrying about this phantom menace — and to stop listening to the people who have been peddling this scare story in an attempt to get their way.”

    Well gee, I guess per this logic there is no reason for Obama to “get his way” on increasing tax revenues by $1.6 trillion over 10 years. Krugman must not think much about the Concord Coalition (those debt scolds!) whose Mission Statement contains this:

    “The Concord Coalition is a non-partisan, grassroots organization dedicated to educating the public about the causes and consequences of federal budget deficits, the long-term challenges facing America’s unsustainable entitlement programs, and how to build a sound foundation for economic growth”.

    On the other hand, there is only one thing one needs to know about Mr. Krugman and this permeates every single thing he writes and this column makes it crystal clear: Write whatever it takes to support taking income from those who have it and giving it to those who don’t, the fiscal deficit be damned. And, I suspect this attitude is shared by the White House. Rhetoric aside, *everthing* the administration has *actually done* suggests it is completely on board with Krugman’s agenda. You see, I very strongly suspect that $1.6 trillion in additional taxes is not and never was intended to reduce the deficit. Why would it be, if it is not necessary to reduce the deficit anyway?

  3. comment number 3 by: AMTbuff

    Wow, Diane, you just barely had room to mention entitlement reform in the last half-sentence of one of your longest posts ever. You had me wondering whether you really think this debate is only about taxes or whether you were merely playing the left’s version of Grover Norquist’s no-concessions game. Trust me: that role is best left to the likes of Paul Krugman.

    We know that spending is increasing steadily as a percentage of GDP and tax revenue is not, based on current tax policy and a modest economic recovery to come. The solution to this structural problem must include structural reform to spending programs. That’s the word you still could not bring yourself to use: STRUCTURAL. Increased eligibility age, means testing, and any other changes which will be POLITICALLY DIFFICULT TO REVERSE.

    Republicans have been quoted several times in the press stating that such structural reforms are their price for revenue increases. Otherwise the extra revenue will be used to delay reform, making it more severe, sudden, and painful, to the detriment of beneficiaries.

    If Obama were to lead with such an offer, he’d be seen correctly as a statesman on this issue. If he were to offer to trade repeal of ObamaCare’s open-ended spending for a package of structural entitlement reforms and revenues, he’d be seen as a saint of fiscal responsibility. That would be a true Nixon Goes to China moment of historic proportions. The economy would skyrocket and Obama would get all the credit. He would deserve it, too.

    As for Krugman, we can only wonder when he will go totally off the deep end on money creation and start selling MMT to his readers.

  4. comment number 4 by: AMTbuff

    Both Republicans and Democrats seem to like this general principle of substituting a broader base for lower rates, and even the particular combination of limits on itemized deductions paired with continued, low marginal tax rates for most Americans.

    Reducing marginal rates for a large majority of upper middle income taxpayers while increasing infra-marginal tax revenue is much more difficult than you might suppose. Martin Sullivan explains: http://taxprof.typepad.com/files/137tn0939.pdf

  5. comment number 5 by: Brooks / Gordon

    AMT,

    http://www.nytimes.com/2012/11/26/opinion/krugman-fighting-fiscal-phantoms.html?_r=0

    Indeed, I almost asked facetiously in my earlier comment if Krugman is coming out as an MMTer. I wish someone would ask him publicly about the implications he makes in that column (the all-gain, no-pain of debt and of printing as much money as we need).

    And while that interviewer is at it, he/she could call him on his straw men — his misrepresentation of “deficit scolds” as being unconcerned with timing, magnitude or form of deficit-reduction, such that (per his straw men) they supposedly want deficit-reduction even amid recession and supposedly contradict themselves for not wanting sudden, large, poorly designed deficit-reduction (fiscal cliff tax increases and sequester). Both are obvious straw men.

    Oh, and with the right, new technology, the interviewer can bring onto the set a surprise guest to debate him…the 2003 Paul Krugman.

  6. comment number 6 by: Brooks / Gordon

    AMT,

    …oops, I didn’t mean to paste the link to Krugman’s column again. I meant to paste:

    As for Krugman, we can only wonder when he will go totally off the deep end on money creation and start selling MMT to his readers.

  7. comment number 7 by: Jim Glass

    Reducing marginal rates for a large majority of upper middle income taxpayers while increasing infra-marginal tax revenue is much more difficult than you might suppose. Martin Sullivan explains:

    The myth is based on an overoptimistic assessment of the effect of tax reform on marginal rates.

    On the one hand, yes, it is obviously true that lower statutory rates lower marginal rates. On the other hand, it is also true — but hardly obvious and almost always ignored — that base broadening through limits on deductions and exclusions often increases marginal tax rates for significant parts of the taxpaying public. Therefore, some or all of the benefit of lower statutory rates on labor supply and savings behavior is offset by the effects of higher marginal rates because of base broadening.

    He’s saying that closing loopholes increases the marginal tax rates paid by the loophole recipients, imposing the economic cost that results from higher marginal rates.

    And it’s back to the Alice Through the Looking Glass arguments over tax expenditures.

    [] Tax expenditures are politically disguised spending on behalf influential special interests, and are functionally the same as cash spending for govt finances — so a trillion dollars of tax expenditure spending distorts the economy just as much as a trillion dollars of overt spending by politicians intervening in the economy, and harms the govt’s finances just as much.

    Thus, cutting tax expenditures is a *spending cut* that improves economic efficiency and strengthens the fisc. It’s a spending cut!

    The Right is supposed to love spending cuts! It’s a spending cut! Spending cut! Spending cut!

    [] Tax expenditures are tax reductions, plainly and obviously. As tax reductions they reduce the distortions imposed on the economy by taxation, and reduce the marginal tax rates of the recipients, thus encouraging them to produce more and grow the economy. The only problem with “loophole” targeted rate reductions is that we can’t have more of them and give them to everybody, so they would be loopholes no more!

    Slashing tax expenditures clearly is a tax increase forcing on the economy all the increased deadweight burden and higher marginal rate economic distortions of a tax increase.

    It’s a tax increase! Tax increase! Tax increase!

    Or back to the beer commercial arguments: “It’s a spending cut!” “No, it’s a tax increase!” “Hey, we’re both right. It’s a spending cut AND a tax increase!”