A New, Simple, Smart Plan for the Fiscal Cliff (and for solving a lot of other problems including sleep deprivation)

July 22nd, 2012 at 9:33 am

Of the various things that keep me up at night, two big ones are, in order, a) the economy has never fully escaped the grip of the Great Recession, and b) we’re collecting unsustainably low amounts of revenue.

Well, in a simple burst of insight, economist Bill Gale solves both with this sentence from a recent oped.  As opposed to squabbling about which part of the tax cuts should sunset, Gale suggests that:

[a] better way to stimulate the economy and move the broader debate forward would be to let all of the Bush tax cuts expire as scheduled and be considered as part of a broader tax reform and medium-term deficit reduction effort, and institute instead an explicitly temporary cut, again a payroll tax cut comes to mind.

If this doesn’t exactly light up that little light bulb atop your head then allow me to elaborate.

The fiscal cliff, as wonks like Ezra Klein have been pointing out for about a year, is unique in that if we do nothing, the tax increases and spending cuts steer us onto a sustainable budget path, one that absent that revenue (that’s the main part of this) would be explosive.

That allows me to go to sleep re worry ‘b’ except for I’m still tossing and turning re worry ‘a.’  But here, the solution, as Gale points out couldn’t be simpler.  Take a small chunk of that new revenue that’s in the new baseline and spend it on temporary stimulus.  He likes a payroll tax cut, and I’m cool with that (general revenue would replenish the Soc Sec trust fund, just as under the payroll tax holiday).  I’d add state fiscal relief and FAST!

But wait, you say!  What about the damage of going over the cliff?  What about the big tax hikes on the middle class, the mindless cuts of the sequester?

All good points, but none are dispositive.  First, as CBPP has consistently stressed, a quick trip down the fiscal slope quickly reversed by a smart plan, would be far better for the economy and markets than another reckless can kick.  The economy can finally get the boost it needs next year by a strong dose of stimulus, and the markets will finally see some fiscal rectitude locked into place.

The tax increases to the middle class can and should be offset by temporary measures like a payroll cut which fade once the economy is back on track.  In fact, since middle class families pay much more in payroll than in income taxes, this is actually a better economic deal for them.  Recent CBO data reveal that in 2009: a) among households that pay both income and payroll taxes, you have to get to the 90th percentile until they pay more income tax than payroll tax, and b) middle income families spent 1% of their income on federal income taxes and 8% on payroll taxes.

Moreover, once we have new revenue flowing in, we can reshape the spending cuts to meet our priorities, including defense, while still sticking to the agreed-upon budget caps.

What’s so fundamentally appealing about this simple plan is that it basically says, “those Bush tax cuts—you know, the ones that started over ten years ago and that we’ve been fighting about ever since…well, they didn’t work.  So let’s finally let them go and start over.”

If, post-sunset, we want to talk tax reform, as Gale suggests above, that’s fine too.  As EPI budget analyst Ethan Pollack pointed out to me the other day (and as CBPP has stressed in tax reform trap discussions) the only time for democrats to safely engage in tax reform discussions is when ample revenue flows are already locked into place, as they would be under Gale’s plan.  Otherwise, lower-the-rates-broaden-the-base risks being reduced to just lower-the-rates.

Finally, it’s really quite shocking how nobody in the policy world is considering ways to deal with an economy that’s now probably growing even slower than we thought.  A research note from Goldman Sachs last week noted that they think the current economy “is growing at little more than a 1% pace.”  That means unemployment doesn’t just sit there, stuck at an already elevated level north of 8%.  It could start going up again.

But what about the politics?  OK, checkmate.  I really don’t know if this plan could work politically because it means that taxes go up on households below $250K and both parties are aligned against that.  As noted, for most families those increases could for now be more than offset by a big temporary payroll tax cut, but this feature could queer the deal.

The other political hurdle is of course more stimulus, which also seems to have been pushed from the policy stage by austerity fever.

So…um…given that those two parts—full sunset and temporary stimulus—comprise the whole plan, this may not turn out to be the way forward and I’ll continue to toss and turn, while the economy bumbles along and the sustainable fiscal path continues to elude us.

But the features of this simple idea are too good to pass up: finally end the destructive Bush tax cuts, not to mention the arbitrary $250K threshold, lock in enough revenue to negotiate any reform from a place of power, and finally blast the damn economy into escape velocity.

What do you think, D’s and responsible R’s?  Worth a try?

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14 comments in reply to "A New, Simple, Smart Plan for the Fiscal Cliff (and for solving a lot of other problems including sleep deprivation)"

  1. marcel says:

    As it is pretty much accepted wisdom in macro that tax cuts known to be temporary have little impact on consumption, I imagine that the point of the temporary payroll tax cut is to help the bottom 90% clean up their balance sheets.[1]

    The previous sentence has 2 parts. If you address this comment, I hope you will deal with both.

    [1] I recognize that I am conflating the bottom 90% of the income distribution with the 90% of households who pay both income and payroll taxes; I suspect that the overlap between these 2 groups is overwhelming, and this is a comment on a blog, fer crissake.

  2. davesnyd says:

    Maybe two weeks ago, you had a post on stimulus spending on infrastructure– I think the gist was that you were proposing new construction. One of the commenters pointed out that renovation and rebuilding of crumbling roads, bridges, water lines/sewers, and the like had the advantage of being more quickly done because less permitting needed to be completed.

    In addition to your targeted tax cuts and FAST stimulus, if you had infrastructure stimulus it would carry two benefits. The economic one is to help put construction workers to work. That’s obvious.

    But there’s a political one as well: there are probably thousands of construction firms which would be lining up to bid on those jobs. It seemed to me that the Administration did a poor job of enlisting them as allies in the first round of stimulus and ought to think how their desire for work/Federally funded projects could be leveraged to help move Chamber of Commerce type organizations towards a position of endorsing stimulus.

    Since our biggest problem in authorizing the stimulus that the economy needs is political, you need to frame any stimulus in a way that puts constituencies pushing for it.

  3. CDW says:

    Name one politician who will _ever_ have the spine to restore the payroll taxes to the status quo ante. The cut is permanent and one that spells the death of SS and Medicare down the road. It is the toehold the right has longed for since the 30s.

  4. Rima Regas says:

    Hmmm! Both you and Bob Kuttner wrote pieces on the same topic today. Yours is more practical and hopeful. 🙂

  5. Bob Wyman says:

    Politics aside, Bill Gale’s approach is wonderful in that it resets taxes to a more proper, stable-state level and then provides temporary stimulus by fine-tuning the disposable income of the spending classes. But, the key there is “Politics aside…” So, given that politics will probably prevent the right thing from happening in any case, why not go for broke and do something really radical? Why not strive to de-politicize some part of fiscal policy in the same way that creation of the Federal Reserve de-politicized monetary policy? For instance:

    Create a “Federal Stimulus Commission (FSC)” whose task is to regularly adjust at least the spending-class’ taxes (payroll tax, etc.) and perhaps some short-term infrastructure budget as well, in such a way that as demand fluctuates, spending-class incomes and infrastructure spending would rise or fall within limits set by Congress but without direct or explicit intervention from Congress. Just as the Federal Reserve is given inflation and unemployment as the metrics to optimize, the Federal Stimulus Commission would be given appropriate targets. The general rule would be that when demand weakens and people start saving, the FSC would increase spending-class incomes and infrastructure spending to provide stimulus. When demand strengthens, the FSC would return to more austere policies and reclaim the revenues needed to pay down the debt…

    Certainly the bulk of fiscal policy will and should always remain political. However, there should be some room at the margin for disciplined, non-political management of fiscal policy. A non-political Federal Stimulus Commission that worked in tandem with the Federal Reserve could go a long way to relieving inevitable swings in economic conditions. The FSC would also serve as the partner that the Federal Reserve needs at times like this when, as Bernanke clearly says on a regular basis, monetary policy alone cannot do the job.

    Yes, I am a dreamer.

  6. Tom in MN says:

    If a middle income family pays 1% of their income in federal income taxes, why are we worried about the Bush tax cuts effect on them? It will be a tiny fraction of one percent change. I seem to recall the average tax cut (as Bush sold his tax cuts) was $2000 but the median cut was $200 (as the majority of the cuts really went to the rich). So I don’t see the worry of letting all the Bush cuts all expire.

    The temporary payroll cuts seem to be much better stimulus. I would also suggest doing the payroll tax cuts by exempting the first $75k of income and raising the taxed income to $250k or more. This would bring in more payroll taxes than a pure holiday while giving only those who would immediately spend it the cut.

  7. Rima Regas says:

    Don’t ever stop commenting or dreaming, Bob!

  8. Peggy Pride says:

    Jared, why didi you ever leave government service? But, as a great resource-your writing and your search for other resources enlighten us nd the hope is somebody in Washington is listening!

  9. procopius says:

    Well, you supposedly have given this a lot of thought and study, but I confess “temporary” cuts to the payroll tax in the face of Grover Norquist and Peter G. Peterson scare the daylights out of me. I think it poses a terrible danger to Social Security by turning it into a welfare program instead of an insurance program that we all have paid our fair share into. And I’m utterly certain it will be pointed to as another reason why Social Security and Medicare are “unsustainable.” The vultures are out there, and have been for 70 years, and they are closer to success than they ever have been. But maybe that’s what we need to wake up the citizens to what is being done to them. Take Social Security away, take Medicaid away, take Medicare away, take food stamps away, they’ve already basically taken welfare away .. and then let the unemployment rate ramp up to 25%. I’m afraid that’s what it will take.