The Only Solution to the Budget Mess: Raising Revenue, Not Taxes

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To avoid default, you need a budget deal. To get a budget deal, you need Democrats. To get Democrats, you need more revenue. To keep Republicans, you can't raise taxes. There's only one solution.

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Reuters

Rep. Eric Cantor's decision this morning to withdraw from negotiations to keep Washington from an historic default reinforces the fact that these negotiations will come down to taxes. But there is reason for hope. Both sides want to make a deal, and both sides know what it will take: a spoon full of taxes to make the spending cuts go down.

With one month to go before the August 2 deadline, there is an emerging consensus among halfway reasonable members of the Republican Party. "We're okay with raising revenue," they say, "but we won't raise taxes."

To some people, this might sound like deliberate Washington gobbledygook, or perhaps a mysterious koan. But it's really quite sensible. All you do is cut out the $1 trillion of deductions, exemptions, and subsidies in the tax code.

You can think of the tax code in two parts: (1) Tax rates take income out of the economy, and (2) tax spending "gives" money back. When you filed taxes this year, the IRS asked you to fork over a certain percentage of your income, but it also helped you reduce your tax bill. Got kids? Tax credit. Got business expenses? Deduct them. Got neither? That's okay, you can still claim personal exemptions and a host of other items that save you money.

These measures, formally called tax expenditures because they "spend" through the tax code, are used to encourage behavior we like. We like houses, so the government spends hundreds of billions of dollars subsidizing mortgage interest. We like health care, so Washington lets employers offer insurance to their workers tax-free. We offer subsidies to companies, to industries, and to consumers, because we think there is lots of behavior worth promoting by making it tax preferable. There are good things about using the tax code to encourage good behavior. But too much of a good thing makes a $1 trillion hole in the middle of our tax code.

The nice thing about all this tax spending (sounds like an oxymoron, but it isn't) is that it lets politicians promote certain behaviors without raising spending. The bad news is that it really is quite a lot like spending. Republican senators Lamar Alexander and Tom Coburn acknowledge that if we're going to cut $4 trillion from our budget in the next ten years, we can't leave one side of the ledger alone and focus entirely on discretionary domestic spending cuts, which account for less than 20 percent of the budget and barely 10 percent of the whole budget picture, taxes included.

Revenue has to be on the table. But tax rates don't. The president's deficit commission reduced marginal tax rates for every family while raising effective tax rates for 80 percent of the country by slimming down these tax expenditures.

To avoid default, we need a budget deal. To get a budget deal, we need Democrats. To keep Democrats, you need more revenue. To keep Republicans, you can't raise tax rates. There's really only one solution. Tax revenue will go up. Tax rates won't.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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