Spending Cuts Guaranteed or Your (Tax) Money Back

    While kibitzing on Twitter this week, another tweeter and I got into a discussion about the GOP's tax strategy and the fiscal cliff.  We continued the discussion via email and after some further thought, I'd like to propose what I believe is a novel approach to the taxes versus spending cuts approach that has bedeviled budget and deficit negotiations for decades.

    One of the infamous examples of a "deal" that ultimately failed is the 1982 TEFRA legislation that Ronald Reagan negotiated with the Democrats in Congress.  As Steven Hayward noted in Commentary Magazine back in 2011:

TEFRA was designed to bring about $3 in spending cuts for every $1 in new revenue, which meant that, on paper, it advanced Reagan’s goal of shrinking the federal government. In practice, the results of TEFRA were almost exactly the opposite. While the tax increases were real, Congress never delivered on the spending cuts. By one calculation, the 1982 budget deal actually resulted in $1.14 of new spending for each extra tax dollar. Obama and today’s liberals have responded with incredulity to the Republicans’ refusal to take a 3-for-1 cuts-to-taxes deal (or a 10-to-1 deal, as was posed hypothetically to the GOP presidential field in an Iowa debate). Some of us have seen this movie before, and we know how it ends.

    I believe that experience more than any other single example has defined conservative, and to a lesser extent, Republican attitudes towards deal-making ever since.  Two of the most iconic presidential quotes on taxes can trace their roots to the TEFRA experience.  Hayward notes the first:

[E]arly in 1985, Reagan invoked Clint Eastwood’s brand-new sound bite when he declared that members of Congress “seem to be in full-scale retreat from spending cuts and are talking about raising people’s taxes again. Well, let them be forewarned: I have my veto pen drawn and ready for any tax increase that Congress might even think of sending up. And I have only one thing to say to the tax increasers: ‘Go ahead, make my day.’”

    The second, also drawn from a movie, was George H.W. Bush's 1988 pledge, "Read my lips.  No new taxes."  But while Reagan held firm and even pushed through the landmark Tax Reform Act of 1986 simplifying the tax code dramatically, Bush famously broke his pledge and was abandoned by voters in droves in 1992 ushering in the era of Bill Clinton.  But 1992 also saw the emergence of the controversial Tax Pledge championed by Grover Norquist.  For two decades, this pledge has been taken by scores of Republican lawmakers and has largely been adhered to.

    However, unlike Bill Clinton after the Democrats 1994 election drubbing, Barack Obama has shown no inclination to work with the Republicans.  And without a majority in the Senate, House Republicans are limited in their ability to influence the debate and force the president to acquiesce to their demands to hold the line against all tax increases.  What then are their alternatives?

    Some have called for another attempt to strike a commitment-for-spending-cuts-for-tax-increases deal.  Obviously, this is problematic on at least two fronts.  First, such deals in the past, as noted above, rarely achieve true spending cuts.  These deals have the ring (this reference may now be archaic) of Wimpy's famous line from Popeye, "I'll gladly pay you Tuesday for a hamburger today."  Nobody really believes it's going to happen.  Second, any agreement to a tax increase could put many Republicans who have agreed to Norquist's Tax Pledge in the same leaky boat George H.W. Bush found himself piloting in 1992 on the way to electoral defeat.  Is there any way to overcome these sizable stumbling blocks that lie near the edge of the fiscal cliff (see what I did there?)

    I'd like to suggest a strategy that could give the Republicans a leg up in the fiscal cliff negotiations.  Rather than agree to a "commitment" to cut spending, write the deal directly into the tax legislation.  Any tax increase would be contingent upon actual reductions in spending, not projected cuts (such as the mythical "$400 million in Medicare cuts" the Obama team has been touting.)  There would be several ways to implement this idea.

    One would be to simply postpone any tax increase until the real figures on government spending are available for a specified period of time, for example, the first six months of 2013.  To the extent cuts are achieved and spending actually dropped, the desired tax increases could go into effect in proportion to the real spending reduction that took place.  Additional benchmarks could be scheduled out into the future and tax increases could even be reversed if spending begins to rise again.

    An alternative would be to implement the tax increases immediately, but after 2013 ends, any failure to reduce spending to targeted levels would trigger a tax credit that those hit with 2012 tax increases could claim, again in proportion to the shortfall in spending reduction goals.  If spending reduction goals were achieved, the credit would be zero.  If spending was not reduced, or it increased, the credit would be for the full amount of the taxpayers' 2012 tax increases.

    Surely there are a variety of other ways to hold government accountable for its actual spending with this money-back guarantee approach, but the Tax Pledge stumbling block still remains.  How could the Republicans justify going along with this increase?  I would suggest a two-pronged approach.

    First, conservatives and Republicans have been warning for years that under the current debt trajectory, effective rates will eventually reach confiscatory and unsustainable levels.  A September Wall Street Journal article by George P. Shultz, Michael J. Boskin, John F. Cogan, Allan H. Meltzer and John B. Taylor (yes, five authors, so it must be true):

What does this spending and debt mean in the long run if it is not controlled? One result will be ever-higher income and payroll taxes on all taxpayers that will reach over 80% at the top and 70% for many middle-income working couples.

     If this money-back guarantee plan actually works, a 10% increase in the top rate for the top 2% of income tax filers will be a small price to pay for real spending reform which is the only way to eventually get everyone's taxes reduced.  Some might say that "a small price" is easy for me to say because I am not in the top 2%, but as the quote above indicates, middle-income earners will soon be in the sights of the tax increasers - the "rich" only have so much money and if spending continues to rise, no one will be safe.  The consolation prize of this plan is that if spending cuts don't occur, no one's taxes go up.  This will be a fiscal disaster for the country, but at least the Republicans can claim credit for protecting taxpayers from paying (at least in the short term) for irresponsible government spending.

    The second prong involves the upcoming expiration of the payroll tax holiday.  As I have written recently, the Republicans have mostly ignored this tax increase, even though it represents a technical violation of the Norquist Tax Pledge.  (This increase will be automatic without legislation to extend it just like the Bush Tax Cuts, so to say one violates the pledge and the other doesn't is disingenuous.)  The Democrats and President Obama have engaged in active misdirection about the payroll tax holiday by claiming the president's plan will prevent 98% of taxpayers from seeing their taxes go up "a single dime."

    The answer is to preserve the payroll tax cut, but shift it away from being a Social Security tax cut to an income tax credit.  The payroll tax holiday was a dumb idea to begin with, the Republicans have a chance now to turn this to their advantage.  Not only can they expose the president's plan to allow this payroll tax increase to take place, by shifting the cut from a Social Security tax to income tax, they can show that the Republicans are the ones preserving the intended revenue stream for Social Security and yet at the same time are the party preventing the middle class and poor from being hit with a tax increase on January 1st (about $1,000 for the average middle class family), a tax increase that President Obama is trying to slip under the radar.

    The mechanics of this tax credit (let's call it the Sustaining Working Americans tax credit) would involve a refundable credit of a flat 2% on Social Security wages (on wages up to the current Social Security tax wage ceiling of $110,100. )  This SWA credit would be available on Form 1040 along with the child tax credit and other such credits applied to gross income tax.  The credit would be refundable to make it available to filers whose tax liability is at or below zero since they too would be hit with the increase from the ending of the payroll tax holiday.

    The bitter pill in this plan for Republicans remains the tax increase on income above $250,000 that the Obama administration is fixated on.  But by acquiescing to the president's key demand, the Republicans can claim the mantle of reasonable compromise, willing to meet the president halfway.  But the money-back guarantee places the onus on the president to actually follow through on spending cuts that he now is able to blue-sky.  And Republicans will be able to clearly show that if the country indeed goes off the fiscal cliff in January, it was no accident - President Obama pushed it off.