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Tax Hikes and the US “Fiscal Cliff”

December 12, 2012

I don’t normally discuss fiscal matters – it is outside the normal themes of this blog and it is also outside my own areas of expertise.  However, fiscal matters are seriously impacting the strategic options of the US, and the long term fiscal position of the nation is at least co-equal to other pressing concerns.

If the United States avoids increasing government spending as a share of GDP, it could actually lower tax rates since, given the U.S. tax structure, revenue generated by income taxes rises faster than GDP. What the country really needs now is to broaden its tax base.

Martin Feldsteian is George F. Baker Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research. He was Chair of the Council of Economic Advisers from 1982 to 1984. Foreign Affairs has published an article from Feldstein that discusses the need to increase tax revenue, but to also avoid serious rate hikes and also to adjust federal spending downward.  This non-ideological piece calls President Obama to task for his recklessness in the fiscal cliff negotiations.

In this confrontation, Obama might believe he has the winning cards. He can hold out until after the first of January and allow the economy to fall over the fiscal cliff. At that point, tax rates would automatically rise on high-income taxpayers. The president could then put forward legislation to cut taxes for the 98 percent of taxpayers with incomes below $250,000, daring Republicans to vote against such a broad tax cut.

That could be a winning strategy, but not necessarily. Since the Republicans control the House of Representatives, they could prevent the president’s plan from coming to a vote. Instead, they could propose a tax cut for everyone that would reinstate the 2012 tax rates. If Obama rejects the cut and the country then slides into recession, the Republicans could blame the situation on his desire to raise tax rates rather than pursue reforms that would raise revenue by broadening the tax base.

Republicans may resist the president’s strategy for reasons of both politics and principle. The political reason is that Republican members of the House have to worry about their next primary campaign. Voting to raise tax rates now, after promising not to do so in the recent campaign, could leave them vulnerable to a challenge from the right.

There is also a matter of principle. Distributional fairness is in the eyes of the beholder. The line between a fair distribution of the tax burden and spiteful egalitarianism is unclear. But many of us believe that placing the full burden of deficit reduction on the top two percent of taxpayers goes too far. After all, if 98 percent of the voters can exempt themselves while raising taxes on just the top two percent — who already pay 45 percent of all personal income taxes — where will the process stop?

Read the whole thing.

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