Congressional Republicans’ strategic shift on taxes
By: Keith Hennessey
Tags: Economy, Budget, Featured, Taxes

For months a common story line in the budget debate has been that a bipartisan deficit reduction deal was impossible as long as Republicans refused to raise taxes. President Obama, Congressional Democrats, and many observers asserted that it would be impossible to solve the deficit problem until and unless Republicans agreed to raise taxes. They further argued that if a deficit reduction deal did not come together, Republican intransigence on this point would be the reason why.

The specific argument was that the deficit could only be reduced through a combination of spending cuts and tax increases. This logic was applied to the Super Committee’s $1.2 — $1.5 T deficit reduction target.

The argument that tax increases are necessary for deficit reduction is not arithmetically true — it is quite possible to completely and permanently reduce, or even eliminate, the budget deficit only by cutting spending. In fact it’s not all that hard to do.

It may, however, be legislatively true that in a politically balanced Washington like we have now, a bipartisan deal with Democrats that does not raise taxes is impossible because Democrats will not agree to deep spending cuts as long as Republicans refuse to raise taxes.

The stalking horse for this argument is Grover Norquist, head of the antitax group Americans for Tax Reform (ATR). ATR’s position is that total federal income tax revenues should not be increased. A deficit reduction package consistent with ATR’s position could increase taxes, it just couldn’t increase income taxes. It could eliminate income tax deductions and credits, but to be consistent with ATR’s view, the higher income tax revenues that result would need to be used in full to cut income tax rates, so that the total income tax burden did not increase. (I use the phrases “total income taxes” and “net income taxes” interchangeably.)

Many DC Democrats argued that Mr. Norquist was really in charge, and that Congressional Republicans were unwilling to cross ATR for fear of political retribution. If there was no deficit reduction deal, we were told, it would be because Grover Norquist, Americans for Tax Reform, and Congressional Republicans all refused to agree to net income tax increases.

The most significant element of the failed Super Committee negotiation is that Republicans offered to cross the no-net-tax-increase line in exchange for structural entitlement reform or structural tax reform and a permanent answer on tax rates. The six Super Committee Republicans proposed a deficit reduction package that would increase net income taxes by about $250 B, plus another $40ish B in higher revenues that would result from correcting the way that inflation is measured. When you add in other “receipts” (which are technically different from tax “revenues”) from auctioning telecommunications spectrum, raising defined benefit pension fees, and asset sales, plus the dynamic effects of high revenue resulting from greater GDP growth (as scored by CBO) that would result, the “tax” (technically, non-spending) component of the Super Committee Republican offer was in the $500 B ballpark.

The six Super Committee Republicans made two offers to Super Committee Democrats:

We will agree to these tax increases if they are packaged with structural entitlement reforms like the premium support system for Medicare assumed in the House budget resolution and if these tax rates are made part of permanent law; or

We will agree to these net tax increases if they are part of a pro-growth tax reform that permanently lowers marginal income tax rates and if they are packaged with significant reductions in entitlement spending growth through incremental, non-structural changes.

This is a stunning move, as almost all Congressional Republicans had previously been unwilling to increase net taxation. Speaker Boehner signaled his willingness to cross the line in his Grand Bargain negotiations last summer with the President. Senator Tom Coburn proposed something similar over the summer, and first crossed the line when he tried to repeal/dial back the ethanol tax credit without using the revenues raised to cut other taxes. Now the rest of Congressional Republicans (or at least the six key Rs on the Super Committee) have joined them. That is a fundamental shift in the budget debate.

The details of the second Republican offer are significant. The SC Republicans proposed to lower marginal income tax rates while increasing average income tax rates. They proposed to eliminate income tax deductions and credits, use some of the revenues raised to lower tax rates, and use some of the revenues raised to reduce the deficit. It’s this last part that is new and extraordinary coming from Congressional Republicans.

This Republican shift means that the earlier narrative that deficit reduction is impossible because Republicans refuse to raise taxes is now invalid. It also invalidates the argument that Congressional Republicans refuse to cross Grover Norquist and Americans for Tax Reform. As best I can tell, the Republican offer is inconsistent with ATR’s position.

I have mixed feelings about this strategic shift:

As a policy matter I hate it. I don’t want to raise any net taxes, period. I strongly prefer to reduce the deficit only by cutting spending, and I fear that in the long run the higher revenues will be used not to reduce the deficit, but instead to finance higher government spending. My biggest concern is that Congressional Republicans might trade permanent tax increases for only temporary cuts in spending growth. If they do, then we will repeat this dynamic several years down the road, only from a starting point of bigger government.

I recognize that legislating in a politically balanced Congress forces compromise, and that one often has to accept things one hates in pursuit of a larger goal. I assume the Republican negotiators thought that this was both the best deal they might get, and that it was better than simply kicking the deficit can down the road another year. Based on what I know of the six Super Committee Republicans, Speaker Boehner, and Senator Coburn, I think most if not all of them hate net tax increases as much as I do.

This shift should advantage Republicans as they compete for the hearts, minds, and votes of those centrists and moderate Democrats who think that spending cuts must be accompanied by tax increases.

Having lost their principal line of attack, the President’s team and Congressional Democrats have therefore moved to two fallback arguments:

Republicans would not raise taxes enough; and Republicans refused to raise taxes on the rich.

Over the next year you will often hear the word “balance,” implying that there is some substantive or moral equivalence between the particular tax increases that Democrats want and the entitlement spending cuts that are arithmetically necessary to solve our long-term deficit problems. I reject the balance concept and its underlying logic, but what’s more important is that you understand the linkage between the balance argument and the earlier, now invalid, line of attack. Every time you hear “balance” as a critique of the Republican position, you should think “DC Democrats are conceding that Republicans have put net tax increases on the table. They just want bigger tax increases and smaller spending cuts than Republicans offered.”

The second argument, that Republicans refuse to raise taxes on the rich, is now incorrect. The Super Committee Republican offer would not just have increased net taxes, as well as net income tax revenues. It also would have increased taxes paid by those with incomes over $200,000. The reform proposed by Super Committee Republicans would have resulted in net tax reductions for income classes below $200,000, and net tax increases for income classes above $200,000 (and above $100,000 by 2021). It would have made the tax code more progressive than it is today.

The net tax cuts for lower and middle-income taxpayers would result from the Republicans’ proposed rate cuts. The net tax increases for upper-income taxpayers would result from eliminating tax deductions and credits that disproportionately affect “the rich,” and that would more than offset the revenue lost to the government by cutting top marginal rates. In effect, the Super Committee Republicans proposed that the rich pay higher taxes as part of a deficit reduction package, while lowering the marginal tax rates that all income taxpayers would face, to get the incentives to work and invest right.

The tax attacks on Republicans therefore look like this:

Republicans refused to raise taxes as part of a deficit deal. No longer valid.

Republicans refused to buck Grover Norquist and Americans for Tax Reform. Invalid.

Republicans refused to raise taxes on the rich. No longer valid.

Republicans would not raise taxes enough .

. Republicans would not raise taxes on the rich enough.

As you follow the deficit reduction debate over the next year, it will be important to remember how significantly the Super Committee Republicans changed the negotiating playing field during these negotiations, and how their offer has changed the nature of the fiscal policy debate.

(photo credit: Sesame Street