Elections have consequences

In terms of Republican conciliation, they are referring to statements like this one by John Boehner, the speaker o...
In terms of Republican conciliation, they are referring to statements like this one by John Boehner, the speaker of the House, and articles like this one by Glenn Hubbard, formerly Mitt Romney's chief economic adviser, both of whom acknowledge that more revenue will have to be part of any effort to narrow the deficit sufficiently to roll back massive automatic sequesters and tax hikes at the end of the year.

Do these, in fact, represent proposals for compromise? Let's look at what they say. Here's Mr Boehner:

"You know, the members of our majority understand how important it is to avert the fiscal cliff. It_s why the House took action earlier this year to replace the sequester with other types of cuts, and it_s also why over the summer we passed a bill to extend all of the current tax rates for one year so that we had time to overhaul our tax code. And it_s why I outlined a responsible path forward where we can replace the spending cuts and extend the current rates, paving the way for entitlement reform, as well as tax reform, with lower rates."

And here is Mr Hubbard:

"What should those negotiating the fiscal cliff do? The first step is to raise average (not marginal) tax rates on upper-income taxpayers. Revenue increases should first come from these individuals. This means closing loopholes. For instance, the Bowles-Simpson commission, which Mr Obama established, has proposed limiting tax preference benefits for upper-income households. Also, Martin Feldstein of Harvard University and Maya MacGuineas of the Committee for a Responsible Federal Budget have suggested caps on the amount of deductions relative to a taxpayer_s income. These ideas are good places to begin.

The second step would be to agree to a package of expenditure reductions to occur over the next 10 years. These would include decreases in the growth of defence and non-defence discretionary spending. Gradual increases in the retirement age for social security benefits will also be important.

The third step is both fundamental and difficult: it is to realise that a strategy of _taxing the rich_ cannot pay for the entitlement state. If we wanted a larger government as a share of GDP, we would have to raise taxes substantially on everyone."

It seems to me that Mr Hubbard has a fundamental and difficult realisation of his own to make, to wit, that the candidate he supported lost the presidential election. The proposals he embraces here, like those outlined by Mr Boehner, were advanced by Mr Romney during the presidential campaign. Mr Romney argued that any increases in revenues ought to come from the elimination of tax exemptions, rather than from hikes in the top marginal tax rate. And like Mr Boehner, he wanted plans for reducing the deficit to somehow lead to tax rates that are lower, rather than higher. Neither Mr Boehner nor Mr Hubbard has signaled any willingness to accept higher revenues from any source other than limiting deductions, or from the hopeful prospect of greater economic growth. That would certainly be nice, but is obviously neither here nor there.

Barack Obama won the presidential election running on an explicit platform of hiking the top marginal income-tax rate to 39.6%, the same rate it was under the centrist neoliberal administration of Bill Clinton in the 1990s. As has been repeated incessantly over the past two weeks, if Mr Obama does nothing, or if the Republican faction in Congress fails to present sufficiently attractive compromise proposals, 39.6% is the level to which the top marginal rate will automatically return. Americans want the wealthy to pay a higher tax rate. The wealthy are going to pay a higher tax rate. Republicans appear to think that by merely stating that they are not in principle opposed to the federal government getting more revenue, they are entitled to be congratulated for their conciliatory approach, despite the fact that they continue to make the same basic tax proposals they made before the election, which they lost, and despite the fact that they have no cards to play; if they don't give ground, they lose.

Behind this practical conflict lies a much deeper ideological one. Mr Hubbard notes in passing, as though it were a universal axiom brooking no dissent: "raising revenue is about raising average tax rates, not marginal tax rates, as Barack Obama_s campaign suggested. Higher marginal tax rates distort behaviour and reduce activity." Sure. So do patents. But as with anything in life, no effect is absolute, and there are always trade-offs. The strength of labour-market effects from rate hikes, ie the elasticity of labour with respect to marginal tax rates, is very much in dispute. A paper in this summer's Journal of Economic Literature by economists Emanuel Saez of Berkeley, Joel Slemrod of Michigan and Seth Giertz of Nebraska says the consensus is that the effects are extremely small: "With some notable exceptions, the profession has settled on a value for this elasticity close to zero for prime-age males." [My bold.] While people might theoretically trade work for leisure when taxes go up, they don't seem to actually do so in practice. Tax hikes on the rich definitely lead them to take more advantage of tax shelters, and may thus be partially self-defeating, but that's very different from arguing that they decrease economic activity; this effect is not strong, and is probably insignificant for the proposed 4.6 percentage-point hike in rates on the very wealthy.

Mr Hubbard is trying to wave away the position that voters support, ie a rate hike for the wealthy, by acting as though the laws of economics decree it foolish. He's mischaracterising the economics; his position here is an ideological creed, one which he will simply have to accept is not shared by most Americans or by the highly-credentialed economists advising the political party that won this election. You will not get a compromise if you try to pretend that your opponents' beliefs can be ignored.

What we're seeing here, in sum, isn't compromise; it's posturing. Republicans are trying to define the press and public's view of what counts as a compromise, by reiterating their existing positions as if they constituted concessions. In itself, the fact that the GOP is posturing to define the compromise is a hopeful sign: it signals that we're likely to get a compromise, rather than self-destructive defiance. But the idea that Democrats will accept the implementation by Barack Obama of Mitt Romney's economic philosophy is ridiculous. If the GOP sticks to this line, don't be surprised if Mr Obama ends up putting off budget negotiations until after his re-inauguration in January, after the tax hikes and defence-budget cuts gradually start to kick in. That might help make it clear where things actually stand, and what an actual compromise between Democrats and Republicans would look like.

By The Economist

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