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By: David Leonhardt
Posted: April 13th, 2012
ON Jan. 1 of next year, the federal tax bill for a typical middle-class household — making in the neighborhood of $50,000 — is scheduled to rise by about $1,750. This increase, which would come from the expiration of both the Bush tax cuts and the Obama stimulus, would follow a decade of little to no income growth for many people. As a result, inflation-adjusted, after-tax income for the median household could fall next year to its 1998 level, in spite of the continuing economic recovery.
The middle-class tax increase is just the beginning of budget changes set to take effect at the start of 2013. Poor families would see their taxes rise somewhat, too. Total federal taxes for top-earning families would rise by tens or even hundreds of thousands of dollars a year. Spending cuts would also take effect, squeezing domestic programs — education, transportation, scientific research — and the military.
All in all, the end of 2012 will be unlike any other time in memory for the federal government.
The tax increases and spending cuts are the result of Washington’s having previously kicked the can down the road, to use a phrase that is popular here. Rather than pass a plan to cut the deficit, policy makers have put off tough decisions. With the Bush tax cuts, lawmakers deliberately made them temporary, to avoid running afoul of budget rules intended to hold down the deficit.
Not surprisingly, leaders of both parties now say they are opposed to letting the changes happen on Jan. 1. Economists are also frightened of what such a sharp shift in government policy might do to a still fragile economy. Ben S. Bernanke, the Federal Reserve chairman, has referred to the various expiration’s as “a massive fiscal cliff.” Congressional aides, quoted in The Washington Post, call it “taxmageddon.”
The problem, as always, is that the two parties cannot agree on what changes should take place. The combination — of political stalemate and potential economic cataclysm — will create an extraordinary period after this year’s election. A lame-duck Congress and Mr. Obama, either re-elected or defeated, will have less than two months to agree on an alternative plan, or the tax increases and spending cuts will take effect.
Optimists — yes, there are still some — say that the prospect of the tax hikes and cuts could finally nudge the two parties to the kind of deficit solution that many experts prefer. It involves sweeping tax reform that would close loopholes, reduce marginal rates, simplify the tax code and perhaps even lift long-term economic growth. Such tax reform has always been easy to put off, but the compromises it requires may end up being easier to accept than taxmageddon.
YET there is still a basic contradiction with which most politicians and voters have yet to grapple, the same contradiction that has helped create this strange situation in the first place. Talking in exasperated tones about the importance of fiscal responsibility is easy. Cutting the deficit is hard, because it involves unpopular tax increases or unpopular spending cuts — and huge cuts if the solution involves only spending, not taxes, as many Republicans urge.
Either way, the changes will affect the vast majority of Americans, given that the deficit reflects a basic disconnect between the government we have and the taxes we are willing to pay. Social Security, Medicaid and Medicare may become less generous. The Pentagon may no longer be able to get just about whatever it wants. Taxes may have to rise from their recent levels, which have been lower, as a share of the economy, than at any point in 60 years. That could mean higher rates. Or, if tax reform actually happens, it could mean smaller tax breaks for health care, housing and retirement savings.
The looming end of billions of dollars in popular government benefits may seem ridiculous. And the fact that Washington keeps delaying a serious deficit plan until another day may seem equally ridiculous. But they make perfect sense in a country where hypothetical solutions are a lot more popular than any actual ones.
Nothing highlights the paradox quite like tax reform.
Most people seem to want tax reform. In a 2011 Pew Research Center poll, 59 percent of respondents said the tax code was so flawed that Congress should “completely change it.” President Obama and Representative Paul Ryan, the architect of the Republican budget plan, each claim to be more in favor of tax reform than the other one.
The notion of tax reform also has widespread support from economists, liberal and conservative. As they define it, reform would reduce marginal tax rates while eliminating or reducing various tax breaks. The tax code would then be flatter and simpler. Individuals and companies would not have to spend so much time and effort filling out their tax returns and figuring out which provisions helped them — an especially appealing notion this time of year.
Nobody knows for sure, but many economists believe that tax reform could lift economic growth, by freeing people to spend and work in the ways they think make the most sense, rather than in ways that happen to reduce their tax bill. Mr. Ryan’s plan would cut the top rate to 25 percent, from 35 percent, and still leave overall tax collection roughly where it has been, by eliminating tax breaks.
What’s missing from these plans is any detail on which tax breaks would be eliminated. Corporate lobbyists, like those at the Business Roundtable, offer an especially telling contrast: they urge the government to reform the tax code while continuing to push for loopholes that benefit them and generally refusing to name loopholes they would close.
The tax breaks that cost the government the most money turn out to be overwhelmingly popular. The three largest are those for health insurance provided by employers, mortgage interest and 401(k)’s. Corporate tax breaks are smaller, but the biggest corporate breaks are often popular, too, like the one for research and development.