The Fiscal Suicide Pact

We must engineer a long-term realignment of entitlements and taxes to avoid falling off the fiscal cliff.

President Barack Obama pauses as he hosts a meeting on Nov. 16, 2012, in the Roosevelt Room of the White House with House Speaker John Boehner and Senate Majority Leader Harry Reid.
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[See a collection of political cartoons on the budget and deficit.]

Right now, our political leadership is playing a game of "fiscal chicken." Both sides have to come together to replace the mindless spending cuts and the tax increases set to take effect on January 1. This is difficult because both sides think that they have the upper hand in the negotiation. The question is whether they will back down before it's too late. A tough deal will require two partners who are in a better mood to compromise than the Democratic president and the Republican leader in the House, but they both must find a way that they can live with, and justify their role as the two main political leaders of America. If we do go over the cliff, it will not only risk another recession but would also intensify a growing conviction that the United States has a dysfunctional political system.

If there was a mandate in this election, it is that the Republicans and Democrats must find a way to work together. Alas, President Obama has not demonstrated a willingness to reach across the aisle. Instead he has alienated and lost the confidence and trust of the Republicans: It's depressing that he has already begun a campaign to have his way. In a recent Wall Street Journal interview, Senate Republican Leader Mitch McConnell made it clear that he has lost trust in this president and had not had a meeting with him in the White House for the last 18 months (remarkably, he did not have one with the president in the first 18 months, either).

The twin prospect of a double-dip recession that would reduce revenues and hence increase deficits should concentrate the most perverse minds.

[Read the U.S. News Debate: Does Barack Obama Have a Mandate?]

Samuel Johnson, the British savant, remarked that the prospect of a hanging tended to concentrate a man's mind wonderfully. So let's hope second thoughts are beginning to percolate in the minds that matter. John Boehner has repeatedly stated his opposition to higher tax rates, but supports raising tax revenues through other means such as limiting the special privileges and revenue offsets that pervade our tax code and largely reflect the political skills of special interest groups seeking to reduce their taxes. Constraining the ability of those who itemize their deductions to lower their taxable income would generally affect only the people in the top 30 percent of the income spectrum, thereby taxing mainly the wealthier, so this approach is also progressive. Boehner prefers bringing higher revenues through eliminating these special privileges rather than through higher marginal rates, which he argues would hit small businesses hard and retard growth.

The president, too, may have opened the door to bringing in more revenue by, in Boehner's words, "closing special interest loopholes and deductions, and moving to a fairer, cleaner, and simpler system." His price for tax reform is that it must be progressive, and so this should provide a basis for compromise.

Boosting marginal rates generally tends to make the earner less likely to work, save, and invest. Reasonable adjustment of or capping deductions for things such as mortgage interest would reduce the federal subsidy to live in a nice house, and increasing state and local tax rates might be an incentive to move or throw the local rascals out at the first opportunity.

[Read the U.S. News Debate: Is Grover Norquist's Tax Pledge Losing Its Effectiveness?]

There are other options. The elimination or capping of deductions that many people now use to reduce their taxes could well yield more revenue than hiking tax rates. For example, if you capped itemized deductions at $50,000, the Tax Policy Center's estimate is that $749 billion would be raised over 10 years, well within the $800 billion that Boehner has previously agreed to. This way, no one's rates go up and the preferential rates for capital gains and dividends are preserved in accord with the Republican agenda. Capping the value of itemized deductions for upper income households at 28 percent would raise $580 billion.