What Tax Hike? The Fiscal-Cliff Deal as a Tax Cut for All

Having had my say yesterday on the fiscal-cliff compromise, I don’t have much to add about how it came about. Except to say that as the House of Representatives debated and passed the Senate bill, I couldn’t help thinking back to 2002 and what Dick Cheney told Paul O’Neill, the Treasury Secretary: “You know, Paul, Reagan proved that deficits don’t matter. We won the mid-term elections, this is our due.”

Rather than obsessing about the carried-interest deduction, the lucrative loophole enjoyed by hedge-fund and private-equity moguls, which has indeed escaped intact, or the unearned goodies that the deal bestows upon various other business interests, such as Midwestern ethanol producers and Puerto Rican rum merchants, I’ve been trying to focus on the larger picture.

It’s a simple matter of logic that when two sides in a negotiation have opposing interests and they need to reach a deal, something has to give. In Washington, that something is almost always the budget deficit. Of course, nobody admits this. From both parties, there is endless talk about the need to match spending to revenues, bring down the national debt, avoid putting our grandchildren into penury, and blah, blah, blah. Cheney, at least, was honest. To heck with the deficit, he told O’Neill. It doesn’t matter anyway. Let’s go and do another tax cut.

I didn’t hear anybody say anything like that on C-Span last night, but for all the horror on the part of the G.O.P. Tea Partiers about having to raise the top rate of income tax rate on households earning more than $450,000 a year, a bit of Cheney-speak wouldn’t have been out of place. A negotiating process that started eighteen months ago with talk of trillions of dollars in deficit reduction ended in an agreement that will hardly reduce the deficit at all. From a historical perspective, indeed, the overall impact of the compromise is to bestow another big and costly tax cut on the American populace.

How can that be so? Under the law of the land as it existed until last night, most of the tax cuts that George W. Bush introduced in 2001-2003 would have lapsed. Now, with the exception of the rise in the top rate of income tax, most of these giveaways have been extended in perpetuity, at a total cost to the Treasury that the Joint Committee on Taxation has estimated at about four trillion dollars over the coming decade.

Even by Washington standards, that’s quite a chunk of change. Rather than going to the federal government, it will be making its way into the pockets of pretty much everybody who pays taxes, even those rich folks who are supposedly being hit with a tax increase. A very useful analysis from the research and lobbying organization Citizens for Tax Justice tells the story. Taxpayers in the middle quintile of the income distribution will get an annual income tax cut of $880 relative to what would have happened if the expiration of the old law had been maintained. Taxpayers in the top one per cent, those poor benighted souls who will be forced to pay the higher top marginal rate, will still benefit from the Bush rate on the first $400,000 of their income; each will save $17,840 relative to a world in which the Bush tax cuts had been allowed to lapse.

So much for Obama crushing the rich, but let’s get’s back to overall figure of four trillion dollars. If it sounds vaguely familiar, it should do. According to the Congressional Budget Office, it’s just about how much budget reduction is needed over the next ten years to keep the debt-to-G.D.P. on a stable path. Let me put that another way. Rather than sticking with a law that would have generated all the revenues we need to put the country’s finances on a firm footing, both parties have colluded in an agreement that will perpetuate large deficits and set up a never-ending series of battles over cutting spending, the first of which will arrive in about two months with a showdown over raising the debt ceiling.

Of course, the Republicans are the biggest offenders. In pursuing their jihad against taxes over the past three decades, they have shifted the political debate so far to the right that even moderate Democratic politicians, such as Obama, have felt obliged to adopt the rhetoric, and policy reality, of tax cutting—even when this involves pretending that two plus two equals five. In a sharp post at the Huffington Post, Jeff Sachs has laid out the some of the offending arithmetic:

Government spending today is around 23 percent of Gross Domestic Product, including 13 percent for mandatory transfer programs (Social Security, Medicare, food stamps, veterans benefits, military retirement, and others), 2 percent for interest, 4.5 percent for the military, and 3.5 for civilian programs. Taxes are around 16 percent of GDP, but would probably produce around 17-18 percent of GDP in a more robust economy.

Allowing the Bush tax cuts to expire today would have raised tax collections by around 2.5 percent of GDP, to around 21 percent of GDP by the end of the decade, thereby allowing the government to pay its bills assuming that the useless wars are ended and the bloated Pentagon budget is brought under control. The Obama-Senate plan will instead keep taxes at around 18 percent of GDP… The Federal Government is being dangerously weakened in its capacity to help America address the economic, environmental, and social challenges of the 21st century.

I’m not a deficit hawk. I worry about the the impact of a hasty shift toward European-style austerity policies, and I am skeptical of long-term budget projections. Hence, I’m not as alarmed as Sachs is by these figures. But it’s hard to quibble with his basic point about Washington, yet again, failing to address the underlying gap between revenues and expenditures. For all the talk of finally getting to grips with the deficit, the system, even with the aid of a self-imposed fiscal cliff, simply couldn’t manage to do it. Don’t be surprised if the ratings agencies take due note.

Of course, the game isn’t over. It never is. In the coming months, we’ll have more spending battles, which, as usual, will prove inconclusive. Outside of mandatory programs, there simply isn’t enough to cut. Inside of them, the political costs of acting are prohibitive. What will happen then? Howard Gleckman, of the non-partisan Tax Policy Center, has the answer: “Sometime soon, lawmakers will almost certainly have to dip back into the tax code for more revenue, making the details of the fiscal cliff deal ephemeral. In short, this budget agreement will accomplish next to nothing. Congress is only buying time—and precious little of it.”

Photograph by Chris Kleponis/AFP/Getty.