Fiscal cliff avoidance beyond the US system

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With less than four weeks left, reaching an agreement to avoid the negative short-term economic impact of the so-called fiscal cliff might be beyond the ability of the strained US political system.

Averting the $600 billion (R5.2 trillion) in automatic spending cuts and tax hikes scheduled to take effect in January, requires one side to give ground on a core belief: either for the Democrats to allow an extension of lower tax rates on top earners or for the Republicans to accept a return to higher rates for those taxpayers.

Both parties agree that any deal will include increased revenue. They disagree over the form of that revenue.

Republicans look to limit deductions that mainly benefit people with high incomes, while extending the 35 percent top income tax rate. This could raise about $800bn over 10 years if the deduction cap is broadly applied, but considerably less if tax breaks such as for charities are left untouched.

US President Barack Obama’s plan raises twice that much through higher tax rates and limits on deductions for households with the top 2 percent of incomes.

Our view is that financial policy must operate on two time tracks: providing near-term support for the still-fragile recovery, while driving the political system to address the long-term imbalance. We propose to let all tax cuts expire and offset the negative economic impact.

Increased revenue comes mainly from higher tax rates rather than from a broader tax base. The higher rates affect all income levels; the alternative minimum tax hits millions it was never intended to reach.

To avoid a recession, we propose temporary tax and spending measures to boost near-term demand without making choices between the agendas of the two parties. We see this last point as essential.

Getting past the cliff with the least damage to the economy requires not making choices about fundamental long-term issues in a lame-duck setting. This means that our proposal does not separate upper-income tax brackets from other tax rates as sought by Obama, but neither does it extend all rate cuts as sought by Republicans. Instead, all tax rates go up.

Our proposals are explicitly temporary. We propose a one-year, $200bn tax refund to support household spending, with rebate checks of about $1 200 for a couple and an additional $600 a child sent out in the first half of next year. We would add $50bn for spending to rebuild roads, repair and modernise public schools, and fund scientific research. An additional $50bn would go to financial relief for states.

Finally, we propose to extend the legislative patch that prevents the alternative-minimum tax from hitting tens of millions of households and the Medicare “doc fix” that averts sharp cuts in payments to doctors serving senior citizens. We also advocate turning off the sequester put in place in August last year that means some $100bn in automatic spending cuts.

All of these proposals together reduce the contraction from the cliff by $300bn and add $300bn to offset the rest of the financial tightening and provide the economy with a near-term stimulus.

This is not a “least common denominator” approach; the fiscal cliff isn’t avoided, as tax rates rise and expenditures decrease in ways that are painful for all people. Yet, it is better than a stalemate that threatens recession. – Bloomberg



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