Everyone in Washington is talking breathlessly about the so-called “fiscal cliff,” and a lot of this talk concerns the expiration of the tax cuts first enacted under President George W. Bush. What is the fiscal cliff, and why is it generating so much hysteria? We explain it below but (spoiler alert) we’ll tell you now, you’d rather drive off the fiscal cliff than see the President accept the deal the anti-tax crowd in Washington is offering. Here’s why.
The fiscal cliff is a set of policies that, if left unchanged, will keep our budget deficit under control. The “cliff” is actually the shape of the line charting the annual budget deficit, which falls dramatically at the end of this year when the Bush tax cuts are scheduled to expire and several spending cuts are scheduled to go into effect.
The majority of that deficit reduction would come from the expiration of the Bush tax cuts—which would allow tax rates to revert to the levels in effect during the Clinton years. It’s not entirely clear why a lot of people in Washington think this would be bad for the economy. Obviously, no one argues that the economy was better after eight years of Bush tax policies than it was after eight years of Clinton tax policies. But some economists believe that the combination of the bad economy, the expiration of the tax cuts, and the scheduled spending cuts—that's spending that employs a lot of people—would have some negative effects.
Even if you believe the expiration of tax cuts and the scheduled spending cuts would hurt the economy, the impacts would be felt gradually over a year, rather than all at once on January 1st. In other words, the fiscal cliff is more like a fiscal slope. So don’t believe the lawmakers and pundits and self-proclaimed deficit hawks who say that Congress must come to agreement before the end of the year to avoid catastrophe. More than anything else, they’re trying to create the sense of desperation and emergency (think Shock Doctrine) that leads to a “solution” that Americans don’t support, a solution they’d mostly oppose if it was debated in an open, deliberative fashion. Recall how 2010 ended with President Obama “compromising” with Republicans by extending every single tax cut they wanted, including those going to the very rich.
None of this matters if Congress enacts President Obama’s proposal to mitigate most of the so-called fiscal cliff by extending the Bush income tax cuts for the first $250,000 a couple makes and the first $200,000 a single person makes. President Obama would also extend the bulk of the estate tax cut in effect now. Altogether, he would extend 78 percent of the Bush tax cuts (in terms of dollar amounts) and only the richest two percent of Americans would have to give up any portion of their current tax cuts. The only reason Congressional Republicans are objecting is because of their obsession with extending tax cuts for the very richest two percent of Americans.
Obama’s proposal extends too much of the Bush tax cuts, but it’s better than most alternatives being debated today. Congress should enact his proposal for one year and use that time to work on real tax reform. This is essentially what the tax bill approved by the Senate over the summer (to which President Obama referred in his November 9th remarks) would do. It would extend the Bush income tax cuts for the first $250,000 a married couple makes and the first $200,000 a single person makes, for one year. The President suggested that Congress then spend 2013 on a larger tax reform package. And there are many reforms Congress could include in an overhaul of the tax code that would really solve some of the problems facing America today.
If anti-tax lawmakers block President Obama’s proposal and demand an extension of all the tax cuts (including those going solely to the richest Americans), then Congress and the President should simply do nothing, and allow the tax cuts to expire as they will, by law, on December 31st. And if necessary, Congress should also allow the scheduled spending cuts to go into effect. Yes, it’s true that certain parts of the tax cuts benefiting low- and middle-income Americans would expire, and that’s not an ideal outcome. But the tax cuts for the rich that Republicans insist on protecting are far, far larger. If they stay on the books, they will eventually make it impossible for us to make investments in things like education, infrastructure and health care that build the solid middle-class foundation that sustains our economy.