By Samuel C. Thompson Jr.
Virtually everyone has heard of the impending "fiscal cliff", which will begin on Jan. 1 if Congress and the president do not take action to avoid it.
Politicians should focus on pro-growth policies first and solve the long-term debt in coming years.
There are two basic aspects to the “fiscal cliff”: First, as a result of concerns Congress has had with the deficit, federal government spending would automatically and significantly decrease; and second, as a result of the repeal of the Bush and other tax cuts, federal income taxes automatically would rise on virtually all taxpayers.
In a November report, the nonpartisan Congressional Budget Office makes it clear that we need to address our long-term deficit and debt problems, which are principally associated with Medicare, Social Security and an aging population.
However, the report also projects that if we go over the “fiscal cliff”, thereby triggering these spending cuts and tax increases, the economy will go back into a recession. Thus, there could be a deleterious effect on the economy if we undertake these austerity measures at this time.
On the other hand, it is important that we engage in long-term reforms of Medicare, Social Security and other entitlement programs so we can ensure the financial viability of these programs.
There is general agreement between the president and Republicans that the spending cuts should be delayed, there should be long-term entitlement reform and there should be no tax increases on families with less than $250,000 of taxable income.
Although Republicans have over the past several years been opposed to revenue increases as a means of reducing the deficit, after the election they have offered to consider new revenues, principally through closing tax loopholes but not through raising marginal rates on families making more than $250,000.
While the president is not opposed to closing loopholes, for the 2 percent of families making more than $250,000, he wants to return to the more progressive rate structure that existed under the Clinton administration.
Under the Clinton rules, taxpayers making $250,000 to approximately $400,000 would see their rate increase from 33 percent to 36 percent on income in excess of $250,000. A family with $300,000 of taxable income would have a tax increase of $1,500, which is 3 percent of $50,000 (the excess of $300,000 over $250,000).
For families with more than $400,000, the 36 percent rate would apply to their income between $250,000 and $400,000, and for income above $400,000, the rate would increase from 35 percent to 39.6 percent.
The Republicans argue that rates should not be raised because they believe that higher rates will harm economic growth. The Congressional Research Service and others have pointed out that there is little support for this assertion.
However, without regard to the merits of this issue, there is a case for not increasing the amount of money being taken out of the economy at this time, which would result from the imposition of more progressive tax rates on those earning over $250,000.
There is a middle ground here. This could be accomplished by giving low- or middle-income taxpayers a tax cut over the next two years that, in the aggregate, would equal the total of the additional taxes generated by increasing the rates on those making more than $250,000.
This policy would spur economic growth and reduce the risk of another recession by boosting the consumption spending component of GDP, a measure of economic growth, because low-income taxpayers are more likely than high-income taxpayers to spend any tax reductions they receive.
Thus, families with more than $250,000 of income would pay a little more in taxes while other taxpayers would pay a little less, and the economy would be given a boost because consumption spending would increase.
After this two-year temporary tax cut, the extra taxes from the reinstatement of the Clinton tax rates for families making more than $250,000 would be directed at deficit reduction, a long-term issue.
Samuel C. Thompson Jr. is professor and director of the Center for the Study of Mergers and Acquisitions at Penn State University Dickinson School of Law.