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Nov 15 2012

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A Real Solution for the “Fiscal Cliff”

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There is a Way Out…

How can you agree on a solution when the parties involved cannot even agree on the problem?

That is where we sit today, 46 days before the USG goes over the “fiscal cliff” unless a tax and spending fix is put in place.

As a function of “social justice,” fair share” or a “balanced approach,” Democrats have their crosshairs on the wealthy, and remain obsessed with raising the top tax rate from 35 percent – established in the Bush tax cuts – to 39.6 percent; as an all-purpose elixir to solve the nation’s fiscal woes.

This is at variance with the actual record, where the current tax code – with the Bush tax cuts firmly ensconced – is returning revenues just shy of those recorded in 2007; a historic year for federal tax collection, despite the feeble economic growth of the Obama years.

Indeed, the social justice argument finds even greater articulation in President Obama’s strategy. Based on his FY 2013 budget proposal, the President would raise $1.6 trillion in new taxes, including a rise in taxes for the top tax bracket, a new millionaire’s tax and ridding the tax code of any loophole that benefit the well-to-do.

It seems that Team Obama care little if these changes impact the still-weak economy, or that when given the opportunity to vote on the President’s budget this past summer, not a single Senator supported it. The proposal went down 99-0.

Republicans, in turn, are more keenly focused on the long-term dilatory consequences of the exploding national debt, and the need to create stable, pro-growth tax and regulatory policies to enable jobs-creating economic expansion that can provide the revenues to fund programs without borrowing from China.

Chastened by their election losses, the GOP is more muted in its proposals, offering new revenue through tax reform – without raising rates – and by tying any deal on revenue increases to real reform in the long-term drivers of US debt, entitlements.

In recognizing the looming fiscal Armageddon on entitlements, the GOP has unlikely allies. The CBO has laid out the challenge in terrifying specificity. And the Washington Post editorial board said today that in addition to the President’s demands for tax increases, entitlement reform should be on the table.

But that is at variance with the position of leading Democrats.

POTUS didn’t say much about entitlements yesterday, but his progressive allies, with whom he met on Tuesday, were very clear that any debt reduction deal was not to touch entitlements. Those sentiments were echoed by Senate Majority Leader Harry Reid, who said in a presser yesterday that any “fiscal cliff” deal-making would exclude Social Security. Reid also ruled out, “changing the way that government benefits are calculated to better reflect the impact of real inflation.” Said Reid, “We are not going to mess with Social Security.”

How do you reconcile the GOP belief in low tax rates and a broad tax base to promote economic growth with a Democratic belief that the top 5 percent of income taxpayers – who already bear nearly 60 percent of the tax burden, pay more?

Yes, there is a way.

The Plan:

The Democratic focus on social justice and burden sharing should be re-focused on entitlement programs and the tax mechanisms to adequately finance them.

The FICA payroll tax that finances Social Security and Medicare – 6.2 percent for Social Security, 1.45 percent for Medicare, capped at $110,100 for 2012 – is wildly regressive and disproportionately burdensome on working class and middle class taxpayers. The Center for Budget Priorities estimates that 75 percent of Americans pay more in FICA taxes than income taxes. The least well off end up paying the biggest share of their income for FICA.

Business-minded Republicans should care about the tax as it inhibits small business creation where the contributions of both the employee and employer are born by the entrepreneur. And a deal to raise the FICA tax does not violate the GOP promise not to raise income tax rates.

So here is the deal:

Uncap FICA: create a pyramid taxation system where without an income cap, where the tax gradually rises to a certain threshold after which, the rate begins to decline again. This provides continued incentive to earn, while maintaining collections. One percent of a million dollars is still 10k. Create a new, blended rate for small businesses to incentivize job creation and entrepreneurship.

In return for GOP agreement to uncap FICA taxes that would fully and robustly fund Social Security and Medicare for the next generation, Democrats would agree to:

Means-Test Medicare and Social Security: wealthier retirees will receive a smaller benefit and pay more for Medicare. So long as retirees receive a minimum of the amount they put into the system, they cannot claim to be shortchanged. This preserves the maximum benefit for those most at risk.

Raise the Retirement Age for Social Security & Medicare: 65 was the retirement threshold in 1935 when Social Security was created. Life expectancy in 1935 was 68. Today Americans can plan on living into their late 70s. Many seniors are living into their 80s and beyond. The programs should keep up with demographics.

Change the Calculation Metric for Inflation: all entitlement programs increase automatically each year based on a government formula for inflation. The chained-inflation index is a closer approximation of real inflation and increases more slowly. There is no cut. Benefits simply increase, at a slower trajectory.

These changes meet both parties’ criteria. For Democrats, the rich pay significantly more, directly to help those most in need, and the programs are firmly established on a paying basis through the baby-boom retirement. For the GOP, the long term drivers of huge deficits are contained through reasonable cost controls that maximize benefits to those most at risk.

Having met the social justice needs of Democrats, elected leaders should look to the current individual and corporate tax structure as a vehicle to catalyze economic growth.

Total Reform of the Tax Code: forget about the Bush tax cuts and other red herrings. These are false arguments.

The last major overhaul of the tax code occurred before there was an Internet. The manner in which Americans conduct business – indeed the way the world conducts business – has fundamentally changed. The tax code needs to reflect that change so we remain competitive.

Start with a clean page. For the GOP, swap existing deductions in the tax code for overall rate reductions. For Democrats phase out popular, politically sensitive deductions (mortgage interest, charitable giving, state and local taxes) at higher income levels. This provides the tax fairness that Democrats seek, while ensuring the lower long term structural rates that Republicans want. The top personal rate should be between 30-35 percent.

Lower the Corporate Tax Rate: America’s corporate tax rate is the highest in the developed world and is essentially a pass-on to consumers. The new rate should be no higher than 25 percent.

Maintain Lower Tax Rates on Capital Gains & Dividends: this is investment money already taxed once as income, something that most fair share advocates don’t understand or recognize. This is a vital pool of capital for business investment. Keeping rates low keeps the funds available, a critical component in economic expansion.

Tie Increases in Non-Defense Discretionary Spending to an Inflation/Population Growth Index: Bill Clinton’s tax increases in 1993 did not balance the budget later in the decade. A Republican Congress instituting fiscal discipline (near one percent growth per year) and the windfall from a cut in the capital gains tax, promoting growth (and the internet bubble) did the heavy lifting. Keeping a lid on discretionary spending while making the tax code simpler, more transparent and incentivizing private sector growth will have the same beneficial impact on the US budget.

That’s the deal.

Everyone gets something, but no one gets everything.

Entitlements are secured and fully funded. The rich pay their “fair share.” Future budget deficit projections shrink as program reforms and new entitlement-specific revenue fill the gap. America’s credit is affirmed, while a pro-growth tax code catalyzes the business community to create jobs, generate profit and rising incomes as well as beneficially augmented tax revenues to the Feds.

Executed properly, and barring a global financial calamity (an every present prospect) the budget would return to balance by the end of the decade, if not before. Any surprise surpluses would – my mutual agreement – be used to pay down principal on the national debt.

The plan is a genuine compromise that nevertheless allows each Party to maintain its core principles. More important it resolves the greatest current threat to American prosperity in one massive move.

Is it doable? There is no better time than immediately after a presidential election to go for the “long ball.” Newly elected presidents must strike before the concrete hardens. A deal along these lines would be a breathtaking achievement for Obama-Boehner-Reid-McConnell.

Yet, the institutional constituencies of each Party that would oppose the plan on narrow ideological grounds are formidable. It is instructive that no plan as remotely far reaching as this has been put forward by either side.

46 days.

Tick, tick, tick……

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