How I’d Avoid the Fiscal Cliff

The election’s over and leaders of the two parties have put their markers down for the next big clash between Republicans and Democrats: how to fix the “fiscal cliff”—the $600 billion of tax increases and spending cuts that, if left intact, would likely throw the economy into recession in the first half of 2013.

Speaker of the House John Boehner has been cautiously conciliatory, while President Obama has repeatedly cited the election as a popular mandate for his “balanced” approach to debt reduction—a combination of revenue increases and spending cuts– although he has also said he’s open to new ideas and compromise.

And he has studiously avoided demanding that tax rates increase, anathema for Republicans. Thus, despite the posturing, both sides have given themselves some wiggle room.

So, here are a few things I’d do to avoid the fiscal cliff:

First, I’d simply extend most of the tax cuts and delay the spending cuts until mid-year 2013, along with a firm agreement on the outlines of a long-term budget deal.

President Obama speaks at a news conference at the White House Wednesday. Source: YouTube/

Then, here’s what I’d eliminate and keep:

End the 2% payroll tax holiday. This was a good short-term fix for the recession, but lately it’s been having diminishing returns. It’s also the principal source of funding for Social Security and Medicare, so we can’t afford to rely on it for the long run. Ending the holiday would add $100 billion in revenues in fiscal 2013 but cost $1,000 per family.

End extended unemployment benefits. I feel bad for the long-term unemployed, but I don’t think yet another year of extended benefits is the answer. (I’d prefer the government put some of that money into training programs.) That would save $25 billion.

Extend most of the Bush tax cuts but get more tax revenue from upper-income taxpayers. I would rather let the Bush tax cuts expire for households making over $250,000 and let the rate revert back to 39.6%, where it was in the Clinton years. But Republicans would never pass anything like that, and we’d be back to where we were last year.

So, first, I’d let capital gains and dividend taxes rise to 20%, from their current 15% for top earners. The top tax bracket will also see a 3.8% increase for dividends in 2013 to help pay for health care reform, pushing the rate to 23.8%. That’s still a lot better than 39.6% (or 43.4% with the new tax), and dividend-paying companies aren’t the biggest job creators, anyway.

I’d also explore Mitt Romney’s idea of limiting deductions for upper-income taxpayers—to, say, $60,000. Households earning more than $250,000 took an average of $130,000 in itemized deductions in 2008. You could cut that dramatically and still preserve, say, charitable contributions while raising considerable revenue. The estate tax also should rise to, say, 35-45% on estates over $3.5 million.

In exchange for that, I’d let the top corporate tax rate fall to 25% or 28%, from the current 35%, but also get rid of a lot of exemptions and loopholes companies currently enjoy, so we’d have a much cleaner, fairer business tax system that actually collects the revenue it’s supposed to.

Any package might also have to include:

  • Raising the future age for full Social Security benefits to 68.
  • Limiting growth in Medicare spending to one or two percent above CPI growth.
  • Raising the income on which payroll taxes are collected for Social Security and Medicare above its current $110,000. That would also be raising taxes on higher income people without hiking tax rates.

I don’t know how much all these ideas would save or bring in—and I haven’t even addressed the discretionary spending side. There are a lot of good ideas out there to deal with this problem. What’s yours? Please comment and join the conversation.

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