Surviving 'Taxmageddon' without maiming economy

It's tempting to pine for the days when Congress wasn't so polarized. A looming fiscal storm highlights how much more challenging our system has become.

By MSNMoney partner Apr 26, 2012 2:58PM

By Peter Orszag


The nation is hurtling toward what has been called "Taxmageddon," the enormous tax increases and spending cuts scheduled for the beginning of 2013. At around the same time, we will also be spending some more quality time with our old friend: the debt limit.


No one can yet see a plausible way through the coming storm. But even though they are not particularly inspiring, paths away from catastrophe do exist.


First, some brief background. At the end of this year, all the Bush tax cuts expire -- amounting to about $250 billion a year. The payroll-tax holiday, at more than $100 billion a year, ends too, as do expanded unemployment-insurance benefits. And we face other spending cuts of about $100 billion, from the sequester set up by the 2011 debt-limit deal.


All told, this fiscal tightening adds up to about $500 billion -- or more than 3 percent of gross domestic product. The economy will be in no shape to handle that much of a squeeze. If we do nothing to reduce or stop it, the economy could be thrown back into a recession.


As if that were not challenging enough, we are expected to bump back up against the debt limit, which currently stands at $16.4 trillion. Projections suggest we will approach the limit in the fourth quarter of 2012. Then, the Treasury secretary will take temporary measures to allow continued issuance of debt. The Bipartisan Policy Center estimates those actions will get us to February 2013 -- at which point we will hit the debt-limit wall. If the economy is weaker than expected, it will widen the deficit faster, and we'll hit the wall sooner.


In thinking through the options for getting past this mess, let's assume that, after this fall's elections, the House of Representatives remains Republican. A presidential victory by Mitt Romney would then probably mean that nothing would get done during Congress's lame-duck session at the end of 2012. After all, why shouldn't House Republicans just wait to deal with the incoming Republican president?


After Romney took office, his administration would presumably negotiate a temporary deal to retroactively reinstate the tax cuts to the beginning of 2013, lift the spending reductions and raise the debt limit for a few months. Republicans would then try to pass a budget resolution and use the reconciliation process -- which allows measures to pass with only 51 votes in the Senate, rather than 60 -- to enact substantial and flawed structural reforms to Medicare and Medicaid (like block-granting Medicaid), and large reductions in programs such as food stamps and Pell Grants.


On the other hand, if Barack Obama is re-elected, an attempt may be made to reach a deal before Jan. 1. The key problem with this scenario is that the Obama administration and House Republicans have irreconcilable differences over the Bush tax cuts: The administration insists that the cuts for people with incomes above $250,000 not be extended again, and the House Republicans insist that they must be. With such a sharp line drawn in the sand, it's not clear how a deal could magically happen before the end of the year.


One possibility would be for the two sides to adopt, during the lame-duck session, a "framework" agreement that would set deficit-reduction goals but provide few, if any, specifics. The tax cuts could be extended and the debt limit raised temporarily as negotiators worked out the details.


Two obstacles to such a framework approach immediately come to mind. First, buying a little more time would only push the problems down the road -- until the next deadline approached. Second, even temporary extensions of the tax cuts would require a compromise: Would we extend all of them (presumably, the administration wouldn't want to) or only those for taxpayers with incomes below $250,000 (House Republicans wouldn't like that)?


Given such difficulties, it might not be possible to reach a framework agreement during the lame duck. Then, all the tax cuts would expire. A dramatic scenario, but this, unfortunately, may be the most likely.


In January 2013, the economy would be hit with a major fiscal contraction, market anxiety would rise, and both sides would blame each other for Washington's dysfunction. But there would be a silver lining: The debate could then move away from the question of which tax cuts to extend.


If we get to that point, the administration could step forward with an entirely different concept for decreasing taxes. It could propose, for example, large increases in the payroll- tax holiday and in the standard income-tax deduction. This would reduce taxes for everyone, but do it in a much more progressive fashion than the Bush tax cuts did. The net result of the new tax cuts and the expiration of the Bush ones would be higher taxes for upper-income people, as the administration desires.


The president could then dare the Republicans to vote against the new universal tax cut. Republicans would have a harder time withholding support for such an across-the-board tax cut in early 2013, once the Bush tax cuts are water under the bridge, than they would have had holding firm on extending all the Bush tax cuts in late 2012.


Resolving the tax issue in that way wouldn't be enough to raise the debt limit and waive the sequestration spending cuts. To accomplish those things, House Republicans will demand some changes to entitlement programs. The question is whether they would push only for the relatively modest reforms discussed last summer (such as using the so-called superlative consumer price index to make cost-of-living adjustments in Social Security) or demand bigger structural changes (such as premium support in Medicare).


It's tempting to feel nostalgic for the days when Congress wasn't so polarized, and the confluence of a substantial tax-cut expiration, a huge spending cut and the debt limit would virtually guarantee a major piece of legislation. Taxmageddon highlights how much more challenging our system has become.


In navigating through the coming storm, we need to avoid undue fiscal contraction (and preferably provide additional support to the economy if the unemployment rate remains elevated) but also recognize that enacting a debt-limit increase will require some long-term deficit reduction -- which would be desirable in any case. The coming debate thus shows, once again, the benefit of a dual strategy in which we continue to provide stimulus to the economy in the short run but enact substantial deficit reduction that takes effect down the road.

More from Bloomberg

Apr 30, 2012 10:22AM

Tax his land,
 Tax his bed,
 Tax the table,
 At which he's fed.
 Tax his tractor,
 Tax his mule,
 Teach him taxes
 Are the rule.
 Tax his work,
 Tax his pay,
 Tax his cow,
 Tax his goat,
 Tax his pants,
 Tax his coat.
 Tax his ties,
 Tax his shirt,
 Tax his work,
 Tax his dirt.
 Tax his tobacco,
 Tax his drink,
 Tax him if he
 Tries to think.
 Tax his cigars,
 Tax his beers,
 If he cries
 Tax his tears.
 Tax his car,
 Tax his gas,
 Find other ways
 To tax his ****.
 Tax all he has
 Then let him know
 That you won't be done
 Till “He Share the wealth .
 When he screams and hollers;
 Then tax him some more,
 Tax him till
 He's good and sore.
 Then tax his coffin,
 Tax his grave,
 Tax the sod in
 Which he's laid...
 Put these words
 Upon his tomb,
 'Taxes drove me
 to my doom...'
 When he's gone,
 Do not relax,
 Its time to apply
 The inheritance tax.
 Accounts Receivable Tax
 Building Permit Tax
 CDL license Tax
 Cigarette Tax
 Corporate Income Tax
 Dog License Tax
 Excise Taxes
 Federal Income Tax
 Federal Unemployment Tax (FUTA)
 Fishing License Tax
 Food License Tax
 Fuel Permit Tax
 Gasoline Tax (currently 44.75 cents per gallon)
 Gross Receipts Tax
 Hunting License Tax
 Inheritance Tax
 Inventory Tax
 IRS Interest Charges IRS Penalties (tax on top of tax)
 Liquor Tax
 Luxury Taxes
 Marriage License Tax
 Medicare Tax
 Personal Property Tax
 Property Tax
 Real Estate Tax
 Service Charge Tax
 Social Security Tax
 Road Usage Tax
 Recreational Vehicle Tax
 Sales Tax
 School Tax
 State Income Tax
 State Unemployment Tax (SUTA)
 Telephone Federal Excise Tax
 Telephone Federal Universal Service Fee Tax
 Telephone Federal, State and Local Surcharge Taxes
 Telephone Minimum Usage Surcharge Tax
 Telephone Recurring and Nonrecurring Charges Tax
 Telephone State and Local Tax
 Telephone Usage Charge Tax
 Utility Taxes
 Vehicle License Registration Tax
 Vehicle Sales Tax
 Watercraft Registration Tax
 Well Permit Tax
 Workers Compensation Tax
 Not one of these taxes existed 100 years ago, and our nation was the most prosperous in the world.
 We had absolutely no national debt, had the largest middle class in the world, and Mom stayed home to raise the kids

Apr 29, 2012 11:01AM
The only tax a final consumption sales tax. When Americans buy groceries and the clack adds $3 for local taxes, $7 for country taxes, $10 for state, $35 for federal tax and $45 to payoff the debt the sh_t will come out of their heads about the cost of government. Socialism will end!!! Then give them the right to directly decide what they are willing to buy though government. We have the internet, we can do it. Our government will become much less expensive and a hell of a lot more productive. 
May 1, 2012 2:46PM

Hypothesis!  Let us take all of the Fortune 500 Corporate profits of this year and pay off - what! Only about 1/2 of the total U.S. Government debt for, yes One Year.


Take all of Fortune 500's leading entaprenures, i.e., Bill Gates, W. Buffett, etc. and pay Almost One Year of the total U.S Government debt; yes One Year.


Now mind you they are then broke too just as the U.S. Government, but unlike the government business and people are not allowed to Print Money.


Folks, we have a spending problem

May 2, 2012 10:50AM

"Taxmageddon"?  Another made up cliche-like buzz word. Sounds good on conservative press shows, but it means bull-crap!

The author has described the items involved and it is the result of congess's gutless inaction, which caused USA  credit rating to be lowered, causing higher rates to be paid on any borrowing. Also caused much panic in the market that most 401K investments and specific stocks and bonds lost value, which they are still recovering from.

So actually the plan to expire tax cuts and reduce the spending on certain entitlements was passed as a backstop and will go into effect at year end. It does not have to be implemented if congress can agree to a plan before then. What do you say to congress, fix it now OR do nothing?

If they do nothing, Then you will have what they want---Taxmageddon.  It is in their power to prevent it now!!


Let's see what they decide!!

Apr 30, 2012 5:08PM

Even calling it "Taxmageddon" is silly. Tax rates on the wealthiest in decades past were much higher than anything they're talking about now, this is relative peanuts. And wonder of wonders, the economy and Americans were doing far better back then, not losing their life savings and wondering what kind of future they'll have.

Don't buy all the noise about the tax increases. They're fair, and long overdue. This incredibly spoiled and selfish generation of swine have been rolling in the mud long enough.

Apr 30, 2012 12:42PM

The tax increases don't bother me nearly as much as the spending cuts, since they'll only apply to the wealthiest people who truly won't be hurt by them, despite their bitching and whining and choruses of crocodile tears.

What I can't for the life of me understand are all those Americans who aren't wealthy, and won't see their taxes go up, crying for the wealthy. Mind-screwed by the likes of Fox News and reduced to manipulated lapdogs. A little fearmongering goes a long way with these people, just create the specter of sinister government wrapping it's giant hand around us all, or "slippery slopes" to Socialism. Oh my!  

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