Fiscal Cliff, Meet Fiscal Norm

Now that the election’s behind us, much US media rhetoric has focused squarely on the impending cliff that is “fiscal”—this week, most of that focus has seemingly been on taxes. With Republicans and Democrats alike gearing up for the tussle, it seems President Obama is preparing to deploy another tactic: a bus tour. Well, maybe not literally, but it does seem the president plans to travel in an attempt to drum up popular support for his proposal to avert tax increases and spending cuts set to kick in at the beginning of 2013.

What exactly is his proposal? He’d like to see a combination of tax increases and spending cuts ... wait a minute—what? We thought that was already Fiscal Cliff’s plan. Presumably Obama would like to reach some compromise that cuts specific spending and less than currently scheduled and increases specific taxes and only on certain groups (primarily the “wealthy”). Sure enough, Wednesday, President Obama made his opening offer, which revolved around $1.6 trillion in tax increases—again, primarily on the wealthy and corporations, though administration officials are seemingly laying the groundwork for more than just that. Treasury Secretary Timothy Geithner actually said:

I don’t see how you do this without higher rates. I don’t think there’s any feasible, realistic way to do it. When you take a cold, hard look at the amount of resources you can raise from that top 2 percent of Americans through limiting deductions, you will find yourself disappointed relative to the magnitude of the revenue increases that we need.

There you have it—maintaining rates while cutting back on loopholes, letting the current rates on high earners expire and certainly cutting rates are seemingly all off the table from a Democratic perspective because none are believed likely to raise sufficient revenue to make a dent in the deficit. Curiously absent from most proposals on the Democratic side are any spending proposals—though one would think given their emphasis on the need for more revenue, they probably don’t plan on cutting much spending.

Meanwhile, on the Republican side of the aisle, leaders are indicating their unwillingness to budge in terms of raising rates on anyone—high earners and low alike. House Speaker Boehner has reiterated his (and ostensibly House Republicans’) willingness to deliver increased revenues, though not through increased rates—instead, through a simplified tax code that eliminates most deductions for high earners.

In principle, this plan makes more sense than discriminately increasing rates on certain folks. Particularly since history has shown if you cut overall tax rates, tax receipts by and large go up—this was true under President Kennedy and President Reagan. It’s not quite as evident immediately following George W. Bush’s original enactment of his now-ubiquitous cuts, but we would suggest that might have had more to do with the rather significant bear market and recession the country simultaneously experienced than tax rates, per se. Particularly since once the country had regained its economic footing, those revenues returned to pre-recession levels (and then some). Considering Art Laffer’s now famous curve, this phenomenon makes sense.

Then, too, it’s hard to make the case our tax code is the most intuitive in the world. Just look at the Alternative Minimum Tax (AMT)—here’s a handy illustration of the various legislation that’s governed the AMT over the years. Note over the last decade, it’s required legislative “patching” annually. And that patching can be quite costly to taxpayers—not only in the sense there’s annually some risk (though we think it likely fairly minimal) legislators finally do fail to patch the AMT and millions more Americans are consequently subject to significantly higher rates; but also in the sense the IRS must adjust accordingly annually. Considering the size and scope of bureaucracy necessary to administer the US tax code, those costs shouldn’t be taken lightly—thoughts on just that well articulated by Acting Commissioner of the IRS, Steven T. Miller, in a recent letter to Senator Orrin Hatch.

And so the debate seems likely to continue along quite similar lines to those we’ve seen over the last couple decades. Politicians will draw their immovable, hard and fast, drawn-in-concrete lines in the sand for as long as they possibly can—until they can’t, and then they’ll find some way to either kick the can or compromise. Many folks fear they won’t do either, and we’ll go hurtling over Fiscal Cliff. But as we’ve said before, Fiscal Cliff has gotten something of a bad rap, in our view—the reality is this is much more characteristic of Fiscal Norm, Fiscal Cliff’s close but oft-ignored cousin.