SuperCommittee Tax Hike Spells Disaster

It would be a great tragedy if a super tax hike came out of a supercommittee compromise deal. It would do great harm to the economy — just as much harm as President Obama’s various tax-hike threats. And on the Republican side, a super tax hike would irreparably split the GOP.

Okay. Here’s the good news. In a CNBC interview this week, I asked supercommittee co-chair Jeb Hensarling about an idea of the Democrats to raise taxes by $600 billion to $800 billion. About $300 billion of that might be up-front, with $500 billion later from some tax-reform overhaul. This would be an unmitigated economic disaster.

But Hensarling was blunt: “Not going to happen, Larry.” He said no such deal has been presented to him. And if it were, he and other Republicans on the supercommittee would not support it.

Hensarling then added, “We put $250 billion of what is known as static revenue on the table, but only if we can bring down rates. We believe we can bring the top individual rate down to 28, 29, maybe at most 30 percent, and bring the corporate rate down to the median of the EU, 25 percent.” For emphasis, he said, “We have gone as far as we feel we can go.”

The Texan was referring to the Sen. Pat Toomey plan, which would lower the personal tax rate to 28 percent and head down from there, while at the same time putting limits on personal deductions (such as mortgage interest) for upper-income taxpayers. In other words, flatten the rates and broaden the base.

Net revenues would go up in this scheme for two reasons: first, the reduction in personal tax breaks; second, the economic-growth impact would be positive. This calls on the research of Harvard professor Martin Feldstein, who urged Congress to trade off lower rates with fewer deductions since the incentive effect of taking home more after-tax income would benefit the economy.

Trouble is, Democrats don’t buy into it — at least not yet. Senate supercommittee members Patty Murray and John Kerry have opposed real tax reform. And it has been reported that House supercommittee member Xavier Becerra opposes it (although Chris van Hollen might be looking at it).

But the whole trouble with the machinations of the two sides in this deficit-cutting episode is that the closer you get to the November 23 deadline, the more compromises are made. Democrats are pulling hard for higher tax rates, which would damage the economy, while Republicans are making no progress getting any meaningful health-care entitlement reform.

And the GOP is in danger of losing the narrative. Most of the noise is coming from Democratic proposals for higher taxes, while Republicans have not taken any entitlement-spending-cut scalps.

In all likelihood, Hensarling will succeed in his conference with the idea of making the Bush tax rates permanent in return for about $300 billion of loophole-closers. The deeper-tax-rate-cut Toomey reform doesn’t seem to be gaining traction.

Trouble is, so called tax reform would probably be handed over to the tax-writing committees in the Senate and House for a decision next year. At deal-time this year — if there is a deal — we won’t know what the tax-rate picture will actually look like. At least that’s a risk. But it’s possible in a worst-case scenario that personal-deduction limits will be hammered out up front, without any assurances of lower tax rates next year.

All this leads me back to this question: Where are the super spending cuts? Nowhere. So why not fall back on the across-the-board budget-cutting trigger known as sequestration? That’s the $1.2 trillion backup plan if a $1.5 trillion deal cannot be reached. (Hensarling called the $1.2 trillion backstop very important.)

Then at least some spending will be cut. And the trigger is probably better than a deal that uses Iraq and Afghanistan spending cuts that would happen anyway or fiddles around with the current-services baseline from which reductions are measured.

For defense hawks who object — since 50 percent of the trigger would come out of national security — any spending measures would have a shelf life of only one year: 2013. After that, new presidents and Congresses will do what they will.

In another interview, congressman Ron Paul (now in a dead heat for first place in Iowa polling) told me the GOP should forget tax hikes and trigger $1.2 trillion in spending cuts. Out on the campaign trail, Newt Gingrich agrees.

But for investors and people in business, a super tax hike would be the worst possible outcome. So take the spending-cut sequestration now, and then fight the real battle in November 2012. That’s better than a supercommittee deal at any cost.