There’s some evidence that President Obama would consider letting all the Bush-era tax cuts expire (see above chart from Strategas Research) at year’s end, even though that would mean a massive tax hike on middle incomers during a time of economic weakness. (Former Obama economic adviser and deficit hawk Peter Orszag is for doing just that.)
Now, Wall Street thinks that level of fiscal contraction would quite probably push the economy back into recession. But that view is hardly unanimous in the economic world. Here’s former IMF chief economist Simon Johnson in an interview with The Fiscal Times (bold for emphasis):
TFT: Let’s turn to the U.S. budget crisis. What will happen to the economy if Congress does nothing and the U.S. walks over the “fiscal cliff” next January by letting all the Bush-era tax cuts expire, including the ones on the middle class, and allows the sequestration cuts to go into effect?
SJ: I don’t think it will be as traumatic as people claim. I think a lot of the hysteria around the fiscal cliff is coming from people who want to keep taxes low. Would it have some contractionary effect? Yes, but not as much as people are claiming. But if you’re worried about it, you should rescind all the Bush tax cuts and replace it with some kind of temporary payroll tax cut linked to employment relative to population. As employment rises to pre-crisis levels, that tax cut should fade away.
TFT: So you’re in favor of a substantial tax increase?
SJ: That’s the point of our book. We need a substantial increase in revenue to meet our obligations over the next several decades because we cut the revenue base too much at the beginning of the 2000s. There was the view that there was a surplus that could be spent. The Baby Boom then was at its peak earning years. We should have been bringing down our debt to pay for their retirement. But we went the other way. Ideally you could phase in that tax increase over a decade. But it’s impossible to get the Republicans to agree on any tax increase. You can’t do a nuanced package with them. So you have to have a confrontational approach.
TFT: On the broader issue of tax reform, you argue in your new book for phasing out or reducing tax subsidies like deductions for home mortgage interest and state and local taxes. Should this be tied to lower rates or be a pure revenue raiser to lower the deficit?
SJ: A lot of what passes for tax reform right now in Washington is actually tax cutting or revenue cutting. On the corporate side, you could do a deal where you broadened the base and reduced rates. It could be revenue neutral because there’s not that much revenue there. But on the individual side, we think top rates need to be put back to where they were before the Bush tax cuts and eliminate or phase out the deductions. But you should rebate about half of it to low income people or people you want to compensate for their losing in those phase-outs.
I wonder if this isn’t the Obama view:
– Tax hikes would ding growth, not destroy it.
– Top rates should be raised and tax breaks scaled back.
– Tax hikes would mean lower deficits and less pressure to trim back the welfare state.
And if that is what the president believes, we just might all go right off that fiscal cliff next year.