Fiscal cliff: Will GOP put taxes on the table to avoid blow to economy?

Calling Democrats’ willingness to allow the country to go over the year-end “fiscal cliff” both “stunning” and “disturbing,” Sen. Pat Toomey (R) of Pennsylvania argued in a speech Tuesday at the Brookings Institution that Republicans had proven a willingness to include tax hikes to fix America’s fiscal trajectory, even in the face of their pledge to never raise taxes.

Senator Toomey's speech comes shortly before Republicans and Democrats will tangle on competing tax proposals on the floor of the House and Senate later this week. Republicans are pushing for a full extension of the Bush tax cuts, saying anything less is a massive tax increase on small businesses. Democrats, on the other hand, say Republicans' lack of willingness to pass their plan – the extension of tax cuts for household income up to $250,000 – right away shows the GOP is holding out higher taxes on 98 percent of Americans for tax cuts on the wealthiest 2 percent. 

Toomey's speech also came in response to remarks from Sen. Patty Murray (D) of Washington, the Senate’s fourth-ranking Democrat, in the same forum the week prior. In her July 16 speech, Senator Murray argued that unless Republicans agree to raise taxes on the rich, Democrats will not back a compromise measure to avoid $600 billion in automatic spending cuts and tax increases on Jan. 1. 

“If Republicans won’t work with us on a balanced approach, we are not going to get a deal,” said Senator Murray,  chairman of the Democratic Senate Campaign Committee, in her speech. “[I]f we can’t get a good deal – a balanced deal that calls on the wealthy to pay their fair share – then I will absolutely continue this debate into 2013, rather than lock in a long-term deal this year that throws middle-class families under the bus.”

New taxes – the “balance” Democrats are seeking in addition to lower spending – are, as Toomey put it, “anathema” to Republicans.

But Toomey had, famously, offered Democrats higher tax revenue during 2011 negotiations aimed at heading off the budget-cutting sequester. They were rejected, Toomey said, because Democrats wanted more. By bringing forward that proposal again on Tuesday, Toomey attempted to short-circuit Democratic attacks that claim Republicans are both ideologically rigid in their approach to higher taxes and willing to make the middle class bear the brunt of any budgetary changes.

The sequester, or the automatic spending reductions mandated by the Budget Control Act, is the result of compromise legislation that ended last summer’s debt-ceiling fight. That legislation increased America’s loan limit in exchange for imposing spending caps on the next 10 years of federal budgets and creating the “sequester” to slash government spending by a predetermined amount (about $1.2 trillion over the next decade) even further if Congress couldn’t agree to deeper cuts. Toomey was one of six Republicans assigned to the so-called “supercommittee,” a bipartisan group of 12 lawmakers tasked with finding $1.5 trillion in debt reduction over the next decade.

The group couldn’t find a formula for offsetting those reductions, and so they’re slated to hit the economy as automatic spending cuts come Jan. 1.
 
But before they announced failure, Toomey offered a plan to offset the $1.2 trillion including $250 billion in new tax revenues coupled with changes to individual tax reform that cut marginal tax rates by 20 percent for every tax bracket. That was alongside changes to Medicare creating higher tax receipts ($150 billion) and $100 billion in non-tax revenues like user fees and asset sales for a total of $500 billion in net deficit reduction.

Those came packaged with a revenue-neutral corporate tax reform (done by lowering rates while eliminating loopholes) and maintaining current tax rates on capital gains, dividends, and estates. The other half of the equation, spending cuts, totaled some $750 billion under the Toomey plan, with the majority coming from $385 billion in changes to Medicare and $210 billion in lower discretionary spending.

“We did recognize [new tax revenues were] politically necessary because it was absolutely essential for our friends on the other side,” for tax increases to be part of a final package, Toomey said.

Referring back to supercommittee negotiations, Murray called Toomey's 2011 plan “stunning” on the Senate floor Tuesday morning. During the supercommittee, Democrats sketched out their opposition to the Toomey plan. The loopholes he proposes closing and the tax changes he wants to make will have to fall on the middle class in order to generate the trillions in savings necessary for a 20 percent reduction in marginal tax rates, they said.

“While Democrats are fighting for tax cuts for the middle class, Republicans are not only holding them hostage to continue the tax cuts for the rich, they are also scheming ways to cut taxes for the wealthiest Americans even more,” Murray said Tuesday.  

Toomey took exception to this Democratic attack over tax fairness, arguing that his tax proposals, in fact, aim at shielding middle class voters at the expense of wealthier Americans. With Republicans resisting Democratic attempts to pass an extension of the Bush tax cuts on only the first $250,000 in household income, Democrats have hammered the GOP in recent days as protecting the rich at the expense of the middle class.

“We stipulated, right at the very beginning, that in this arrangement, all the net new revenue would have to come from the top two [tax] brackets,” Toomey said.

He argued that even if Democrats didn’t like his specific methods for getting to lower overall tax rates, his guiding principle of avoiding raising taxes on the middle class means he was willing to work on just how to get there.

“I was not religious about exactly what mechanism would occur,” to get to the lower rates, Toomey said.
 
So why would Democrats balk at his plan?
 
First, they would argue that you simply can’t get to Toomey’s numbers without raising taxes on the middle class – the deductions that are most expensive, such as deductions for mortgage interest, also benefit middle-class Americans in droves.

Second, by handling the tax code as a part of a small-bore reduction of long-term federal deficits – Toomey’s overall plan amounts to $1.2 trillion while many economists believe $4 trillion is a minimum amount of debt reduction over the next decade to put the US on stable fiscal footing – could set the stage for deeper spending cuts going forward, because taxes would be effectively settled.

“You have then baked into the tax code a permanent solution that rules out the balance between spending and revenues we’re going to need,” said Bill Galston, a senior fellow at the left-leaning Brookings Institution, in a panel discussion after Toomey’s speech. “If you broaden the base profoundly, which he is suggesting, you lower the rates by 20 percent, that is the new long-term baseline for tax policy and that does not generate, in my judgment, nearly enough revenue.”

Asked how his plan jibes with anti-tax crusader Grover Norquist’s pledge (of which Toomey and nearly all other congressional Republicans are signees) to never raise taxes, Toomey said that he was willing to offer a small tax hike in order to head off a massive one. And by linking his proposal to tax reform which lowers marginal rates, conservatives could argue that they set up a much larger boost to government revenues through economic growth.

“We’re not unaware of the political environment,” Toomey said. “The only way we were going to be able to justify putting revenue on the table would be in the context of pro-growth reform that would offset the damage to come via tax increase and expecting it to come from the top brackets.”