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Column: President, Congress face critical decisions about budget

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Before President Barack Obama’s second term, he has some crucial business with the “lame-duck” session of Congress.

Because of temporary tax cuts, previous budget deals and procrastination in dealing with the debt, the country now faces a “fiscal cliff” on New Year’s Day. The stakes are high. All working households are scheduled to pay more taxes. And a feeble labor market and a macro economy are bracing for the impact of much higher taxes and, perhaps, reduced government spending.

The key factors are the Budget Control Act of 2011 and the scheduled end of a handful of tax cuts. The act lays out automatic budget cuts to be split between military and domestic spending: $55 billion in both categories. This would result in a 9 percent cut to the Pentagon and an 8 percent cut in domestic programs — but only when compared with their regularly scheduled increases.

The tax increases would be much larger: about $500 billion overall or what the Urban Institute’s Tax Policy Center estimates to be $3,500 per household on average and $2,000 for “middle income” households.

About $156 billion of this is the expiration of the Bush-Obama income tax cuts — a big hit for the half of households who pay federal “income taxes.” Marginal tax rates would increase across the board — from 10 percent to 15 percent on the lowest end and 35 percent to 39.6 percent on the highest end. The child tax credit would be reduced from $1,000 to $500 per child and no longer would be refundable.

As for the famous tax cuts on those earning over $250,000, their expiration would raise about $23 billion. Higher tax rates for all capital gains and dividends would raise about $25 billion. The estate tax is currently 35 percent on wealth over $5.12 million and would revert to 55 percent on wealth over $1 million, raising about $10 billion from business owners, farmers and other wealthy people.

There are four other significant tax increases on the horizon. First, “accelerated depreciation” would end — a subsidy to business that artificially boosts the attractiveness of capital.

Second, Congress will consider another Band-Aid for the “alternative minimum tax,” an arbitrary limit on loopholes. If not, the minimum tax would expand from 5 million to 25 million households, raising their taxes by $3,700 on average.

Third, ObamaCare will add new taxes of $23 billion, mostly from a payroll tax increase on high incomes.

Fourth, Obama’s “payroll tax holiday” will expire, increasing taxes by $125 billion on all workers.

Of course, all of these are estimates. We know higher taxes will reduce economic activity, harming individuals and the macro economy. But we don’t know how much the economy will be harmed by — or how strongly people will respond to — higher taxes.

The White House’s 2013 projected revenues assume an 18 percent increase in individual income taxes and a 41 percent increase in corporate taxes. I’m not sure how much of the predicted increase assumes higher tax rates and how much is optimism about economic recovery. But it’s difficult to be optimistic about the economy when it’s lukewarm and about to be saddled with big tax increases.

The problem is that we have massive deficits and rapidly growing debt. The nonpartisan Congressional Budget Office says that we need “fundamental” reform. The White House estimates that revenues will cover only interest on the debt and “entitlement” spending in 2012. All other functions of government are being financed through borrowing.

Continuing this will lead to bankruptcy. We’re speeding toward a “debt cliff,” but fixing the problem will be painful.

To reduce deficits, we need reduced spending or higher tax revenues (not necessarily the same as higher tax rates). We know that much higher taxes cannot work, because economic activity will stagnate or disappear as rates increase. Beyond that, your policy preferences will depend on your confidence in government’s ability to spend money better than the private sector — and your ability to imagine more subtle costs of tax increases, compared with more obvious costs of spending reductions.

What to do? It’s doubtful that enough of our elected officials have the courage to cut spending, so the rich are an attractive target. They’re a small minority and can be easily tagged in a democracy.

Politically, the GOP may be better off to join the president here. It wouldn’t raise much money, but it would show willingness to compromise and remove a big distraction.

Then we can focus on the critical choice: big spending cuts versus big middle-income tax increases to close the budget chasm caused by our elected officials.

D. Eric Schansberg, an adjunct scholar of the Indiana Policy Review Foundation, is a professor of economics at Indiana University at New Albany. Send comments to letters@dailyjournal.net.

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