Deficit Reduction Deal: 3 Dueling Plans to Achieve It

Liberal economist Robert Reich and conservative economist Greg Mankiw advocate different approaches

President Barack Obama has upped his revenue target as fiscal cliff negotiations are set to start. (Photo: AP) President Barack Obama has upped his revenue target as fiscal cliff negotiations are set to start. (Photo: AP)

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How to close a budget gap that has exceeded $1 trillion in each of the last four years and avert a “fiscal cliff” of austerity cuts and tax hikes that threaten recession is the subject of White House negotiations with congressional leaders starting Friday.

In a surprise move, President Barack Obama, perhaps emboldened by his strong showing at the polls last week, jolted the familiar ground of those discussions with a call to raise revenue by $1.6 trillion over 10 years, twice the revenue goal he laid forth in budget talks held one year ago.

As the politicians prepare their negotiation stances, liberal and conservative economists are offering their ideas on how to solve America’s growing fiscal gap.

In a blog post published Saturday, Greg Mankiw, chairman of the Economics Department of Harvard University who served as an advisor to Mitt Romney’s campaign, approvingly cited an idea from the Tax Policy Center that would raise revenue without increasing tax rates.

By capping itemized deductions at $50,000, the center–a joint project of the Brookings Institution and the Urban Institute–says revenues would increase by $749 billion over 10 years. That’s about half the president’s current goal and nearly all of the amount the president was seeking just a year ago. And nearly all of that revenue would come from the nation’s top earners, the center says.

According to Mankiw, “this may be the germ of a possible deal between President Obama and Speaker (John) Boehner: The speaker agrees to this tax hike if the president agrees to some fundamental reform of the entitlements, such as gradually but significantly raising the age of eligibility for Social Security and Medicare.”

But such a deal is far from acceptable to Robert Reich, University of California at Berkeley professor and former secretary of labor in the Clinton administration. Reich, in a blog post published Monday, advises the president to seek even more revenue while completely shielding entitlement spending.

Setting $4 trillion–“the consensus of the Simpson-Bowles Commission”–as his revenue goal, the former Cabinet secretary outlines four steps to closing the U.S. fiscal gap.

Reich says he’d get the first trillion (over the next decade) by raising taxes on the rich: “Why not go back sixty years when Americans earning over $1 million in today’s dollars paid 55.2 percent of it in income taxes, after taking all deductions and credits?”

Additional surtaxes on wealth would bring the next trillion:

“A 2% surtax on the wealth of the richest one-half of 1 percent would bring in another $750 billion over the decade. A one-half of 1 percent tax on financial transactions would bring in an additional $250 billion,” Reich writes.

Reich again looks to taxes for most the third trillion: “Raise the capital gains rate to match the rate on ordinary income and cap the mortgage interest deduction at $12,000 a year, and that’s another $1 trillion over ten years.”

And he manages to come up with the final trillion without touching the middle class or Social Security, Medicare or Medicaid:

“Eliminate special tax preferences for oil and gas, price supports for big agriculture, tax breaks and research subsidies for Big Pharma, unnecessary weapons systems for military contractors, and indirect subsidies to the biggest banks on Wall Street, and we’re nearly there. End the Bush tax cuts on incomes between $250,000 and $1 million, and–bingo–we made it: $4 trillion over 10 years.”

To conservative economist James Pethokoukis, writing on the American Enterprise Institute’s AEI-Ideas blog, the approach taken by Reich (whom Pethokoukis does not discuss) wrongly focuses on the deficit while avoiding the true focus, which should be on nominal GDP. Pethokoukis cites a research note by MKM Partners economist Michael Darda that says U.S. deficits have mushroomed as GDP has plunged below trend.

So, by focusing on reigniting economic growth, the deficit disappears, Pethokoukis argues, approvingly citing Darda’s recommendations to “close the growth gap in a potentially bipartisan way.” Those recommendations include GDP growth target combined with reform of entitlements and the tax code.

In a separate blog post published Wednesday, Pethokoukis criticizes the president’s $1.6 trillion tax hike proposal, saying “73% of the savings comes from taxes, 27% from spending cuts. That’s $3 of tax hikes for every $1 of spending cuts.”

He adds: “Obama is making the exact mistake Europe is making by employing a tax-hike heavy version of fiscal austerity.”

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