Any day now the White House and the Congressional leadership will announce an agreement to avoid going over the fiscal cliff on New Year’s Day; it will be a “down payment” on a comprehensive deficit reduction plan to be negotiated in 2013.

They will declare the obvious: to reduce annual federal budget deficits and prevent America’s $16 trillion public debt from hitting $23 trillion in ten years, government spending will be cut and taxes will go up.

Today we examine the tax part of this equation.

President Obama has been saying for months that as the first step toward deficit reduction the rich should be “asked” to pay “their fair share.” Read more.

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Fiscal Cliff Grinch: Taxes!

Mon Dec 17, 2012

Any day now the White House and the Congressional leadership will announce an agreement to avoid going over the fiscal cliff on New Year’s Day; it will be a “down payment” on a comprehensive deficit reduction plan to be negotiated in 2013.

They will declare the obvious: to reduce annual federal budget deficits and prevent America’s $16 trillion public debt from hitting $23 trillion in ten years, government spending will be cut and taxes will go up.

Today we examine the tax part of this equation.

President Obama has been saying for months that as the first step toward deficit reduction the rich should be “asked” to pay “their fair share.”

Specifically, he has proposed that the Bush-era income tax rate cuts, scheduled to expire this December 31, be extended for all taxpayers except individuals making over $200,000 and couples making over $250,000. This would mean that the present marginal tax rates of 33% and 35%, on incomes between $250,000 and $388,350 and above $388,350, would revert to the higher Clinton-era rates of 36% and 39.6% respectively.

Citing the support of a majority of Americans as well as his own re-election, the President insists that he will not sign into law any fiscal cliff legislation that does not include an increase in tax rates on wealthy taxpayers. He argues that continuing lower tax rates for 98% of Americans should not be held hostage to keeping tax rates lower for the richest 2%.

To be sure, the White House has signaled some flexibility on the precise rates and taxable incomes the President might agree to—he might, for example, accept 35% and 38% on incomes over $500,000.

Congressional Republicans, on the other hand, oppose raising anyone’s tax rates. They assert (1) that the economy is too weak to raise taxes; (2) that many small business owners pay individual income taxes and will be hard hit by a tax hike; and (3) that the main cause of $1 trillion+ annual budget deficits and a $16 trillion public debt is over-spending not under-taxing—and that additional tax revenue will be used not for deficit reduction but to underwrite more government spending.

A further complication is that President Obama’s plan to raise the top two tax rates on taxable incomes over $250,000 is estimated to raise only about $80 billion in additional revenue annually, roughly 7% of the FY 2012 budget deficit of $1.1 trillion. In other words, hiking tax rates on the rich would help only marginally to address titantic deficits and debt. It would help even less if a final agreement shaved back the maximum rates and taxable incomes.

All this means that to accomplish the goal of reducing federal budget deficits and getting America’s massive public debt on a more sustainable path, the tax revenue component of any longer term package must include more than higher tax rates on the rich.

Which is why Capitol Hill Republicans and Democrats are exploring ideas for broadening the income tax base through so-called “tax reform” measures. While not likely to be included in any last minute fiscal cliff legislation this year, consideration is being given to scaling back the value of various tax deductions, credits, exclusions and loopholes.

The President has actually proposed capping all such tax incentives at the 28% tax bracket—which would have the effect of denying the full value of deductions like charitable contributions to taxpayers in the highest brackets—36% and 39.6% if the President gets his way. This proposal will be studied carefully in 2013.

In the meantime  some 14 days remain, including the Christmas holidays, for Congress and the President to hammer out a deal to avoid going over the fiscal cliff.

Lawmakers will notice that this Friday, December 21, marks the winter solstice, the longest night of the year and the first day of winter. They have no doubt been informed that the ancient Mayan calendar apparently predicts the end of the world on this year’s winter solstice. While it won’t be the end of the world if Republicans and Democrats fail to reach agreement, a bipartisan compromise to reduce deficits and debt will boost the economy and brighten everyone’s prospects for a Happy New Year.