The lame-duck Congress and just plain lame President are leading the nation towards the Fiscal Cliff created by last year’s budget compromise. Republicans want to make the necessary spending cuts, while Democrats seek to redistribute wealth by taxing the rich. In particular, Democrats seek to force Republicans who pledged not to raise taxes to do so, to damage them politically with their base. Democrats recall their 1990 success in chiding then-President George H. W. Bush into breaking his famous “read my lips” pledge and then hammering him relentlessly for doing what they prodded him to do, leading to Bush’s resounding defeat for reelection.
Beyond that political reason, Republicans also resist tax increases because they understand (and Democrats don’t) that rate increases do not necessarily result in revenue increases, because higher taxes reduce consumer spending and cost jobs. Republicans particularly appreciate the negative impact of tax-increases on “the wealthy” on small-business job creators.
Unfortunately, Republicans control only the House of Representatives, and action to avert the Fiscal Cliff requires the cooperation of an uncooperative Democrat president and an uncooperative Democrat majority in the Senate. Averting the fiscal cliff (and the destructive military cuts that would ensue) regrettably but necessarily requires compromising on “revenue.” The key is to identify and utilize revenue sources that either don’t or only minimally hinder job creation. I identified some sources in an earlier post, but some sort of rate increase will also be necessary in order to feed the egos of Democrats who are willing to drive the country over the cliff in order to force tax rate increases down the throats of their hated Republican rivals. The Associated Press reports* that some Democrats, led by Sen. Patty Murray (D-WA), even advocate doing nothing to avert the cliff, for the purely political motive of gaining bargaining leverage.
Here’s an obvious idea. Go ahead and raise the rates for income exceeding $250,000 back to Clinton-era rates, but exempt small business income from the increases. Income from wages, salaries and “passive income” from dividends, interest, royalties and the like which exceed $250,000 in the aggregate would be subject to the higher rates, but the job creators would continue to be subject to their current rates. And make these permanent (as permanent as any Congress is empowered to do), to relieve the job creators of the uncertainty that has hindered them throughout the recession.
Computing business income separately from non-exempt income is easy enough to do. Just use the same method currently used for the separate computation of the tax on qualified dividends and capital gains.
No, this isn’t a perfect plan. Taxpayers subject to the higher rates may not be making hiring decisions, but they are still likely to reduce their consumer spending, which will reduce the amount of tax revenue expected to be generated by the increases. This is reminiscent of the 1990s, when Democrats decided to soak those evil, selfish rich people by enacting an excise tax on yacht purchases, which caused yacht purchases to plummet, which put lots of union boat-builders out of work. Duh! The public outcry forced the then-Democratic Congress to retreat with their tails between their legs and repeal their crown jewel of wealth redistribution. The current proposed rate increase won’t be as targeted as the yacht tax, but private discretionary spending will go down with fewer and/or less expensive vacations and the like, and the lowest-income people will again bear the brunt of the policy. But that’s the bed the Democrats make, and we should make them sleep in it.
But if we can avoid the draconian cuts to our national security without hamstringing the job creators, let’s do it. It’s the best we can hope for in this divided government.
*The St. Louis Post Dispatch printed part of the AP story (without naming any names), buried on page A15 of its November 14, 2012 issue, but had scrubbed the story from its web site by the time this post was written.