Obama tax-cut plan: easing risk of 'fiscal cliff'?

Not extending the Bush-era tax cuts for the rich could cut the federal deficit by $81 billion in 2013, but it could also damage the economy by reining in spending by the highest-earning Americans.

President Obama didn't use the word "fiscal cliff" Monday when he proposed extending middle-class tax cuts, but his proposal relates directly to the fears embodied in that phrase.

The so-called cliff is this: Under current law, the scheduled expiration of major tax breaks at year end raises worries that the nation could be pushed back into recession as millions of consumers simultaneously get hit with higher federal taxes.

The president urged that Congress act now to keep the Bush-era tax cuts in place for about 98 percent of Americans for 2013. But he would allow the Bush-era tax cuts on higher-earning Americans to expire. The plan fits with Mr. Obama's longstanding views on tax policies, and with his election-year strategy of casting himself as for the "middle class" and Republicans as for "the rich."

But, if enacted, it would also have big implications for the trajectory of federal deficits – and for the risk of a recession induced by those expiring tax breaks.

Essentially, Obama is proposing to turn that dreaded economic cliff into more of a gradual slope.

Taxes would still go up for families earning more than $250,000. The White House estimates that, by bringing in more revenue, this would shrink the federal deficit by some $83 billion in 2013.

But economists generally say the move, by taking spending power out of the hands of high-earning Americans, would also dent current economic activity. For reference, that $83 billion equals about half a percent of America's gross domestic product, or GDP.

Forecasters don't believe the hit to GDP would be precisely that size. What they do say is that, if all the currently scheduled tax-cut expirations occur on Dec. 31, a new recession is a very real threat.

A government report Friday showed only tepid job growth in June, highlighting the economy's fragility and its importance in the election campaign.

Obama's proposal on continued tax cuts for the middle class would reduce the overall size of what some analysts have dubbed "taxmageddon." Keeping those cuts in place would push up the 2013 federal deficit by some $108 billion, Congress's Joint Committee on Taxation has estimated. In turn, that leaves more money in consumers' hands, reducing the size of the cliff that might damage economic growth.

Obama threw down a challenge to Republicans: "Let's agree to do what we agree on," he said, for the good of the economy. Both parties have embraced the idea of keeping tax rates low for most Americans. Obama said the two sides should act on that idea, for 2013 at least, and then debate their differences on policy toward the rich during the election campaign.

Some economists, including Federal Reserve Chairman Ben Bernanke, say the economy requires a two-part fiscal strategy. First, avoid the full-scale cliff of tax hikes and scheduled federal spending cuts, to stave off a possible recession. Second, put the federal budget toward more stable footing for the long term, such as by imposing spending restraint that kicks in gradually, as well as by reforming the tax code.

The Obama plan for middle-class tax cuts is not a full-fledged fiscal plan. But economists on the left argues that it's better than doing nothing. Continuing the middle-class tax breaks could mitigate the recession risk. Meanwhile, allowing tax rates to rise on well-to-do Americans could reduce federal deficits significantly. It would bring in $829 billion extra revenue during the next decade, according to the liberal Center on Budget and Policy Priorities (CBPP) in Washington.

Without that tax revenue, the government would face pressure to make deeper spending cuts to get its fiscal house in order.

In making his appeal, Obama differed with some in his own party. House minority leader Nancy Pelosi (D) of California, for example, would keep Bush-era tax rates in place for those earning up to $1 million.

But bumping the tax-hike threshold upward from Obama's target of $250,000 in income would cost the government a lot of revenue.

"House Minority Leader Nancy Pelosi's proposal to extend President Bush's income tax cuts for households making up to $1 million a year would lose nearly half of the revenue that President Obama's proposal ... would raise," according to a CBPP report.