In early 2012, Federal Reserve Chairman Ben Bernanke used the term “fiscalcliff” to grab the attention of lawmakers and the broader public. Bernanke’spoint was that Americans should worry about the combination of federal tax increases and spendingcuts that are currently scheduled to begin at the end of this year.
But there is not really any kind of “cliff” in the sense that if you stepped over the edge, you would fall fast, land onsomething hard, and not get up for a long time. In the modern US economy, thescheduled changes constitute more of a fiscal “slope” – meaning that the fulleffect of the tax increases would not be felt immediately (income withholdingtakes time to adjust), while the spending cuts would also be phased in (thegovernment has some discretion regardingimplementation). This slope offers President Barack Obama a real opportunity torestore the federal government’s revenue base to what it was in the mid-1990’s.
The choice of words to describe America’s fiscal situation matters, giventhe hysteria that has been whipped up in recent months, primarily by people whowant to make big cuts in the country’s two main entitlement programs, SocialSecurity and Medicare. Their logic is that if we are about to rush off a cliff, we need to take extreme measures.And cutting pensions and health care for the elderly certainly qualifies asextreme – as well as completely inappropriate and unnecessary.
If, instead, the US faces a fiscal slope, then people who refuse toconsider raising taxes – namely, Republicans in the US Congress’s House ofRepresentatives – have a very weak hand indeed.
It has become clear that the House Republicans will steadfastly refuse to vote for any increases in taxrates during the current lame-duck congressionalsession. House Speaker John Boehner, who offered relatively conciliatory remarksimmediately after the election, now says that he would accept higher revenuewith lower rates – precisely what the temporary tax cuts enacted by George W.Bush’s administration were supposed to deliver, but manifestly did not.
It is very unlikely that congressional Democrats and Republicans can reachan agreement on extending the Bush-era tax cuts for the middle class, whileallowing them to expire for the rich. They will sparwith each other for another six weeks, then go to the brink of the purported “cliff” and see who blinksat the last moment.
The sensible course of action for Obama would be tostep off the “cliff” by vetoing anyextension of the Bush-era tax cuts, which would then expire at the end of 2012.Once tax rates were restored to their previous levels, Obama could present hisown tax-cut package to Congress – for example, with a proposal in early Januarythat provided greater benefit to lower-income Americans, as he promised duringhis re-election campaign.
These tax cuts should also be linked to the state of the economy, so thatthey would wind down as employment recovers (forexample, to its level in 2007, relative to total population). If the economylooks weaker than anticipated in early 2013, the proposed tax cuts could belarger (as long as they were phased out duringthe economic recovery). This approach would significantly transform America’slonger-run fiscal prospects.
Then, as America heads steadily down the fiscalslope in early 2013, the House Republicans would have a choice. Do theyvote, week after week, against tax cuts that would help 100 million Americans,while the economy deteriorates around them? Or do they embrace a deal that cutstaxes and tax rates relative to where they would be otherwise?
In effect, the House Republicans can be forced to sign onto a deal thatboth supports the economy and restores revenue to the level that prevailedbefore the disastrous experiment of Bushonomics.
Obama has already put spending cuts on the table – probably to a greaterextent than would please his electoral base (he does have a tendency to dothis). The big question is whether the US can strengthen revenue in anappropriate manner that is consistent with renewed economic growth.
America should aim to return to the tax rates of the mid-1990’s, when theeconomy was booming and the federal budget was in much better shape. But itshould do this fully only once the economy has completely recovered.
Ordinarily, partisan political gridlock in Washington would prevent anysuch sensible change. Fortunately, the fiscal slope gives Obama the opportunityto bring it about – and even to write some history in the process. That meansvetoing any extension of the Bush-era tax cuts, and then working to enact theObama tax cuts.