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Fiscal cliff opportunity for U.S. tax reform

By: Staff Writer

Posted: 11/16/2012 2:32 PM | Comments: 0

If there’s one iron law of American politics over the last three decades, it’s that cutting taxes is far easier than hiking them. Most Republicans in Congress, in fact, have pledged never to raise rates on anyone. This refusal, combined with an inability to rein in spending, explains why the government has been running $1 trillion deficits year after year.

So for supporters of financial sanity, there’s an appealing aspect to the "fiscal cliff" looming at the end of the year. If Congress does nothing, something it does very well, taxes will go up $388 billion in 2013 alone, making a huge dent in the revenue problem. Spending also will plunge.

The catch, of course, is that virtually all economists say that such a sudden, massive shift would kill the fragile recovery and plunge the nation back into recession. This gloomy prospect — devised a year ago by Republicans and Democrats as a device to force compromise – now has them back at the bargaining table, starting with a meeting Friday at the White House.

At this point, there should be no doubt that new revenue needs to be part of the solution. During the Obama administration, tax receipts have been equal to about 15 per cent of the economy, the lowest level since Harry Truman was in the White House. Simpson-Bowles and other deficit commissions have sensibly recommended raising about $1 in revenue for every $3 in spending cuts.

So how to do it?

Start with two steps at year’s end: Allow rates to rise on the wealthy, as President Obama wants, and let the payroll tax that funds Social Security revert to its normal amount of 6.2 per cent. This would shore up the retirement program, which has been paying out more than it is taking in, and demonstrate that allowing temporary tax cuts to expire needn’t be ruinous.

Then, in 2013, the White House and the new Congress could tackle the more complex issues of tax reform and cost cutting, particularly in Medicare.

One approach on revenue would be simply to phase out all of the George W. Bush tax cuts and let rates return to levels they were at during the Clinton administration, when economic growth was robust and budgets were balanced. But neither Obama nor Republican congressional leaders appear willing to go in this direction. And allowing rates to go back up does nothing to simplify the hideously complex tax code, which, at more than 73,000 pages, forces taxpayers to devote huge amounts of time to tax preparation.

So that leaves tax reform — a broad-based simplification effort that raises more money by curbing the $1 trillion a year in deductions, credits and loopholes that have turned the tax system into Swiss cheese. Beyond cleaning up the code, tax reform has the benefit of providing cover to the Republicans who’ve signed the pledge not to raise tax rates.

One intriguing approach, suggested by Mitt Romney during the presidential campaign, is to create a fixed-dollar cap covering all deductions. Many of the existing deductions and credits could remain, allowing lawmakers to avoid battles with powerful lobbies fighting to preserve them. Setting the cap at, say, $35,000 would mean higher taxes for the wealthy but would impact the middle class modestly, if at all.

At the same time, reform should ensure that everyone above the poverty level pays at least some federal income tax. This would reinforce the notion that all Americans have a stake in funding the essential functions of government and squelch the makers-vs.-takers argument.

By doing these things, government leaders could raise needed revenue. Combined with cuts in major entitlements, they could reach a deal that would tame the deficit. If it takes the prospect of going over a cliff to get something done, then so be it. Nothing else has worked so far.

— USA Today

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