The Most Important Thing Missing From the Proposed Fiscal-Cliff Deal

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The payroll tax cut is set to expire, and with it, about a half million jobs in the coming year

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(Reuters)

Well, it's about time to say goodbye to the fiscal cliff. But don't worry if you're a fan of manufactured crises -- Congress has already created a new cliff to replace it, the debt ceiling cliff, that will hit in a few month's time. The era of perma-emergency is far from over, even if the fiscal cliff might be.

The latest proposal could easily fall apart since it has yet to deal with the sequester cuts, but it looks like Democrats and Republicans are close on a deal when it comes to taxes and stimulus. Here's how it breaks down.

TAXES

-- Rates rise to 39.6 percent on income over $400,000 for individuals or $450,000 for couples. 

-- Capital gains and dividends taxes would rise from 15 to 20 percent -- which is really 23.8 percent when you include the Obamacare surtax -- for individuals making $400,000 or couples making $450,000

-- Limits on itemized deductions and exemptions, so-called Pease and PEP, would kick back in for individual/joint filers making $250,000/$300,000 and $375,000/$425,000, respectively.

-- The estate tax would be set with a $5 million exemption and a 40 percent rate (in a rather costly move).

-- Permanently patch the Alternative Minimum Tax (AMT), to prevent increasing numbers of middle-class families from getting hit with the tax each year due to inflation.

-- One-year extension of business tax extenders, like the R&D tax credit and accelerated depreciation

STIMULUS

-- Continue extended unemployment benefits for one more year, which the Congressional Budget Office (CBO) figures will add 300,000 jobs in 2013.

-- Continue the expanded Earned Income Tax Credit (EITC), Child Tax Credit, and American Opportunity Tax Credit (AOTC) for college students for five-years. These partially refundable credits, meaning you can still get them even if your tax liability is zero, were originally expanded in the 2009 stimulus, and are a big, big deal to households making $30,000 or less, as you can see in the second chart here.

-- One-year extension of the so-called "doc fix" that prevents Medicare payments to doctors from getting slashed.

-- There is no new infrastructure spending and no continuation of the payroll tax cut.

The end of the payroll tax cut, and the lack of any substitute, is the biggest thing missing from the fiscal cliff deal. Without it, the Tax Policy Center figures middle-class households will see their after-tax incomes fall around 1.5 percent, which the CBO estimates will cost us around a half million jobs. Why has the payroll tax cut become such a political orphan? Well, Republicans aren't crazy about more stimulus, and Democrats aren't crazy about a tax cut that makes Social Security more dependent on general revenues, and thus less politically solvent. But there is a way around this. It's an idea Democrats used in 2009 and floated again a few months ago, before dropping. That's bringing back the Making Work Pay tax credit -- and doubling it. 

Making Work Pay was the one stimulus tax credit that didn't survive past 2010. It mimicked the payroll tax cut, except it worked through the income tax, so it didn't deplete the Social Security Trust Fund. Households got a refundable credit equal to 6.2 percent of earned income, with a maximum credit of $400 for singles and $800 for couples. Republicans didn't like it, so the payroll tax cut replaced it in 2010. 

It would be particularly farcical to replace the payroll tax cut with something it was designed to replace, but that seems perfectly fitting for Washington, especially when it comes to the fiscal cliff. But as Dylan Matthews of the Washington Post points out, the payroll tax cut is almost twice the size of Making Work Pay, so the latter would have to be doubled to fully replace the former. The chart below, from the Tax Policy Center, makes just that comparison of the payroll tax cut and a doubled Making Work Pay credit for different income groups. Making Work Pay would pay more for households making $75,000 or less, and a lot more for households making $50,000 or less.

MakingWorkPay.png


If the Democrats want to trade tax revenue for tax credits, as seems to be the case, they should at least hold out for the most stimulative credit out there. Making Work Pay puts more money in the hands of working and genuinely middle-class households -- households that are more likely to spend that money, and thus put people back to work.

A fiscal cliff deal that raised revenue from the rich, gave tax credits to the middle-class, and delayed the sequester -- along with the no-brainers like extending unemployment insurance, patching the AMT, and doing the doc fix -- is a deal both sides could get behind. Democrats would get a bit less revenue than they want, Republicans would give up a few more credits than they want, and everybody would avoid the austerity that nobody wants.

That would be a grand enough bargain.
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Matthew O'Brien

Matthew O'Brien is a former senior associate editor at The Atlantic.

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