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A New, Simple, Smart Plan for the Fiscal Cliff

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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 op-ed. 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 Social Security 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, Democrats and responsible Republicans? Worth a try?

This post originally appeared at Jared Bernstein's On The Economy blog.

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