Dec 06 2012 -
Fiscal Cliff: How to Protect the Middle Class, Sustain Long-Term Economic Growth, and Reduce the Federal Deficit
This is last hearing of the Joint Economic Committee during the 112th Congress. On behalf of Vice Chairman Kevin Brady, the other Republican Members, and myself, I wish to thank you, Sen. Casey, for your service as the 36th Chairman of the Joint Economic Committee.
The 2010 election gave control of the House of Representatives to the Republicans and the Senate to the Democrats. Consequently, this unique Committee was equally divided. While such division would have normally produced gridlock in Washington, Chairman Casey and Vice Chairman Brady worked together and shared responsibility for organizing Committee hearings. Because of your bicameral and bipartisan cooperation, the Joint Economic Committee emerged as a widely respected national forum for debating important economic issues.
Therefore, I wish to thank you, Chairman Casey, for your leadership during the 112th Congress. I also want to recognize three retiring Members for their contributions to the Committee:
• Sen. Jeff Bingaman of New Mexico
• Rep. Maurice Hinchey of New York
• Sen. Jim Webb of Virginia
In Federalist 70, our first Secretary of the Treasury, Alexander Hamilton observed, “Energy in the executive is a leading character in the definition of good government.” In a divided government, the President must lead and not abdicate his responsibility.
President Obama has the responsibility to propose a real, bipartisan plan to avert the fiscal cliff that can pass both Houses of Congress. Drawing from the recommendations of his Bowles-Simpson Commission, the President could propose a plan that not only averts the fiscal cliff, but also turns us away from the fiscal abyss by reforming Social Security, Medicare, Medicaid, and ObamaCare to make them sustainably solvent. If President Obama were to offer such a plan, Republicans would react favorably.
Going over the fiscal cliff is economically irresponsible, financially reckless, and entirely unnecessary. Yet as Kimberley Strassel observed in The Wall Street Journal, “The president is boxing in the Republicans—offering them a deal they cannot accept, a deal they can't even be seen to be treating seriously.”
First, President Obama has repeatedly called for a “balanced” solution involving both more revenue and less spending. Yet, his plan is far from balanced. The fiscal cliff involves nearly $4 of anticipated revenue from higher taxes for every dollar of spending cuts. Yet, the President wants even more revenue and fewer spending cuts than if we fell off the cliff. His plan even includes a new round of stimulus spending. That’s very unbalanced.
What the President’s plan lacks is any entitlement reform. The unrestrained growth in entitlement spending is driving federal spending, budget deficits, and debt ever higher as a percent of our GDP. The unfunded liabilities of the U.S. government are estimated to be as high as $128 trillion. Even confiscating all income in excess of $1 million cannot pay for all of entitlement commitments that the federal government has made. Without sensible entitlement reform, our credit rating will be downgraded again and again, putting us on the road to becoming Greece.
Second, fiscal consolidation plans, such as the President’s, which are heavily weighted toward higher taxes, fail to achieve their government budget deficit and debt reduction goals. Dr. Hassett has examined fiscal consolidations in 21 other developed countries. On average, unsuccessful plans were composed of 53 percent revenue increases and 47 percent spending cuts, while successful plans were composed of 15 percent revenue increases and 85 percent spending cuts. Moreover, the higher revenues in successful plans were generally from non-tax sources such as asset sales and higher fees for government services.
Third, the President argues that if the 2001 tax reductions for the middle class are extended, raising marginal tax rates on the “top 2 percent” will not harm our economy because it won’t affect consumption expenditures much. However, Drs. Robert Carroll and Gerald Prante of Ernst and Young analyzed the combination of the expiration of 2001 tax reductions for the “top 2 percent” and the expansion of the Medicare tax and its extension to capital income. Under President Obama’s preferred tax policy, top rates will rise:
• From 35 percent to 40.9 percent on ordinary income;
• From 15 percent to 44.7 percent on dividends; and
• From 15 percent to 24.7 percent on capital gains.
The long-term consequences of President Obama’s preferred tax policies would be devastating:
• Output would fall by 1.3 percent, or about $200 billion in today’s dollars;
• The capital stock would be 1.4 percent smaller;
• Employment would fall by 0.5 percent, or about 710,000 jobs; and
• Real after-tax wages would fall by 1.8 percent relative to what would otherwise occur.
Fewer jobs and lower real wages resulting from higher taxes on the “top 2 percent” harm the middle class.
The Statistics of Income (SOI) data from the Internal Revenue Service (IRS) reveal three important facts about the income and tax payments of high income earners:
• The income and tax payments of the wealthy rise much faster than the income and tax payments than everyone else during economic booms, but fall much faster during busts.
• The wealthy earn and report more income when income tax rates are low than when they are high.
• Adjusting for the business cycle and stock prices, higher effective tax rates on the wealthy will actually generate only about 10 percent to 20 percent of the revenue anticipated on a static basis.
There are better ways to increase federal revenue than hiking tax rates. Congress could enact a pro-growth tax reform that lowers rates, while eliminating or limiting special interest tax deductions, credits, and exclusions. President Obama could open more federal lands and offshore areas to energy exploration, development, and production. And his Administration could take a more balanced approach to new regulations.
Economic growth can help to solve our fiscal problems. If the economy had grown by 16.8 percent, as it had averaged in previous post-war recoveries, instead of the 7.4 percent that it did, and revenues had returned to the 18.2 percent of GDP as they were in the third quarter of 2007 before the recession, the Treasury would have collected an additional $653 billion in fiscal year 2012, and the federal budget deficit would have fallen by more than half from nearly $1.1 trillion to $436 billion—still bad, but remarkably better than where we are.
Republicans stand ready to work with President Obama for a truly balanced, bipartisan solution.
Individuals and businesses are looking for the federal government to lead and create a long-term, stable regulatory structure that will enable growth. Unfortunately, because of the impasse in Washington, the business community continues to be stifled. At present, no business knows what its tax rates will be going forward or which federal spending programs might be changed on January 1, 2013. In September of this year, I held an economic summit in my district in which Richard Fisher, President of the Federal Reserve Bank of Dallas, was in attendance. Fisher describes the business community’s position on the looming fiscal cliff as, “without some certainty, businesses can’t budget, can’t plan and can’t run the risk of hiring and expanding beyond their replacement needs.” This is the kind of outlook that cripples job creation and the ability of businesses to realize their potential.
Let us temper this fear by creating a long-term solution that does not burden individuals and gives businesses the optimism that going forward will invest in our economy again.
With that, I look forward to the testimony of today’s witnesses.