The political debate now taking place over the fiscal cliff has come down to a standstill over the issue of a higher tax rate for persons making over $250,000 per year. Obama insists on it; the Republicans refuse it. This posturing is absurd on both sides. This single issue represents only 4% of the income taxes and 4% of the deficit.  

The Political Debate

Normally, we attempt to avoid taking a political viewpoint at Briefing.com. However, on this particular issue, we feel compelled to criticize both sides equally strongly. 

The problem is that the central issue being fought over has minor value in the overall fiscal cliff picture. 

The Obama administration is insisting that any extension of the current, but expiring, income tax rates apply only to those persons making less than $250,000 per year. 

The Republican House is insisting that any extension of the expiring tax rates not include a rate increase for anyone. 

As we noted in last week’s Ahead of the Curve column, the value of raising taxes on persons making over $250,000 is just $42 billion in calendar year 2013. 

This value is derived by analyzing the Congressional Budget Office analysis of the economic impact of various aspects of the fiscal cliff, as published in their report titled "Economic Effects of Policies Contribution to Fiscal Tightening in 2013." 

(This report is available at the following url: http://www.cbo.gov/publication/43694)

In this report, the CBO never directly states that the value of taxing revenues above $250,000 has a value of $42 billion, but that value can be extrapolated by two separate numbers the CBO does calculate, whose only difference is the taxation of income above $250,000. 

The following table illustrates this extrapolation. 

Source: Congressional Budget Office

The first two rows in this column are projections made by the CBO. The third row is the implied value of taxation of incomes above $250,000, since this is the only difference between the items in the first two rows. 

As this table shows, the revenue value of this taxation is $42 billion. The economic value, or impact on GDP, is a mere 0.1%.  Projections of GDP are not even accurate to levels of 0.1%, particularly when such forecast is made for a quarter that is a full year away. 

The fiscal cliff scenario is one which assumes no extension of expiring tax cuts and no revocation of the discretionary spending cuts mandated by the Budget Control Act of 2011. 

In this fiscal cliff scenario, the CBO projects a deficit of $641 billion. 

In the CBO’s “alternative fiscal scenario,” the CBO projects a deficit of $1,037 billion. 

The alternative fiscal scenario is one where one where the following occurs: 

• Extension of the expiring tax cuts, except the payroll tax, and indexing the AMT to inflation 
• Elimination of the sequestration spending cuts in the DOD
• Elimination of spending cuts in non-DOD discretionary spending 
• Medicare’s payment rates for physicians remain unchanged from the current amounts

The alternative fiscal scenario does not include revenues from increasing tax rates for persons making above $250,000. 

With a deficit of $995 (the projected alternative scenario deficit of $1,037 minus the added $42 billion in new taxes), the taxation of incomes over $250,000 is just 4.2% of the total deficit. 

This means that the total “value” of taxing incomes over $250,000 is “worth” just 4.2% of the deficit problem and 0.1% of GDP growth, using the CBO projections. 

In addition, since projected total income taxes in 2013 under the alternative fiscal scenario are approximately $1,000 billion, the taxation of incomes above $250,000 represents just 4% of total income taxes. 

When viewed in this light, the fight over taxation of incomes over $250,000 can only be viewed as absurd. 

From a purely financial viewpoint, the issue is almost  minimal. 

It becomes even less important when considering the CBO made no correction or assumption for the change in persons behaviors that might allow avoidance of taxing income over $250,000. 

Since many persons with incomes over $250,000 have some degree of control over their actual income, the calculated $42 billion in new revenue might actually be overly high. 

The Political Fight Trumps Financial Sense

What this all means is that neither side in the fiscal cliff debate has made attacking the deficit a priority. 

Instead, the debate is being focused on who is going to get “the blame” for whatever happens. 

While we said we try not to take political stands in our analysis, we do believe that the federal deficit and federal debt problem is a significant issue. 

Unless the excessive deficit spending of the past four years is curtailed in the next four years, the United States will be serious trouble with respect to payment of the debt. 

For example, if an additional four years of $1 trillion deficits were allowed to occur, the total debt of the US would be over $20 trillion dollars. 

The CBO’s projected nominal GDP at the end of 2016 is $18.6 trillion.  

This would place the total debt-to-GDP ratio at 108% of GDP.  

This is seriously dangerous financial territory. It is unlikely that the extremely low interest scenario of today could be maintained for four years. 

The issue of deficit spending has to be addressed at some point, sooner or later. 

However the current political landscape in Washington is clearly choosing political posturing over a relatively minor issue instead of making serious attempts at curtailing deficit spending. 

Ironically, this means the only serious attempt at curtailing the deficit spending problem is the course of inaction by Washington, invoking the fiscal cliff scenario. 

The current deficit, at $1.1 trillion for fiscal year 2012, would then be cut in half, with a CBO projected deficit of just $641 billion. 

Maybe it is better in the long run if we do go over the fiscal cliff. 

Comments may be emailed to the author, Robert V. Green, at aheadofthecurve@briefing.com 

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Definitions: 

The Fiscal Cliff 

The so-called fiscal cliff consists of the expiration of a number of legislative acts, ane the introduction of new taxes, including: 

• Bush Era Tax Cuts  - the Economic Growth and Tax Relief Reconciliation Act of 2011 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 
• Obama Era Tax Cuts – the American Recovery and Reinvestment Act of 2009 
• Estate Tax Cuts - Part of the EGTRRA, but analyzed separately by the Tax Policy Center
• Expiration of Alternative Minimum Tax Increase, indexed to inflation, also part of the EGTRRA 
• Payroll Tax Cut  - the cutting of the Social Security payroll tax from 6.2% to 4.2% in 2011
• New Taxes created by the 2010 Health Care Legislation 
• Extenders – a variety of short tax provisions enacted individually – these are analyzed as a group by the Tax Policy Center and include such things as accelerated or bonus depreciation for businesses and work opportunity tax credits. (In this summary, we will ignore summarizing these, as they are numerous, but individually small in impact) 

All of these various items either expire or become law on January 2, 2013. 

The total of all these are collectively referred to as the “fiscal cliff.”

The CBO Alternative Fiscal Scenario 

The CBO does not make any predictions as to the likelihood of Congressional action. 

However, the CBO did create an “alternative fiscal scenario,” which is defined as follows: 

• Extension of the expiring tax cuts, except the payroll tax, and indexing the AMT to inflation 
• Elimination of the sequestration spending cuts in the DOD
• Elimination of spending cuts in non-DOD discretionary spending 
• Medicare’s payment rates for physicians remain unchanged from the current amounts

This scenario allows for a more readily digestible analysis of the most likely legislative action on the fiscal cliff.