A simple plan to avoid the fiscal cliff, fix the deficit, boost the economy, and end partisan gridlock.

Here are two things about me you may not know: 

1)   I’ve pretty seriously addicted to armchair political strategy.

2)  I spent nearly two years professionally analyzing the minutiae of U.S. fiscal policy at Bridgewater Associates (the world’s largest hedge fund.) [1]

In the aftermath of the election, I’ve noticed that for the first time in years, political conditions may actually be right to allow a simultaneous solution to many of America’s serious economic and fiscal problems. So I’d like to throw out a modest proposal.

First, some context:

Everyone has heard that the U.S. has a deficit problem. But that’s not quite true. We actually have two deficit problems. Our long-term deficit is unsustainably large. Over long periods of time, we simply cannot spend more money than we earn. But our short-term deficit is actually too small. Put simply, the economy is bad because the U.S. private sector is still heavily in debt. The only way to fix that (other than muddling through for twenty years like Japan) is to have the government inject enough money into our economy to let people earn their way out of debt. That means lower taxes and/or investing in infrastructure, education, and research. (That’s what the stimulus did, and it worked. It just wasn’t enough.)

At the same time, we have two political problems. On November 6th, the American people voted for the status quo. So just like before, we have a GOP house committed to avoiding tax hikes. And we have a president committed to raising taxes on the rich while avoiding spending cuts that hurt the poor.

All these problems are imminently coming to a head as enough tax cuts expire and spending cuts take effect on Jan 1st to drive the economy back into recession.

Luckily, everything has a pretty simple solution.

First, forget about renewing the Bush tax cuts and throw out the cuts-or-sequestration compromise. Let’s wash our hands of that entire mess. Obama can fulfill his campaign promise of not extending cuts for the rich, and Republicans can fulfill their promise of not extending anything without cuts for the rich.

That whole issue circumvented, we’ll replace the Bush tax cuts with a bill that does four things: 

1)   Boost growth by cutting taxes – As Romney proposed, cut income tax rates ~20%  across the board. But only cut them by ~5% for income over $250,000. [2]

2)   Make the rich pay more by simplifying the tax code – Eliminate virtually all tax breaks and loopholes for the rich. Make the next multimillionaire candidate for president unafraid to release his tax returns by making it impossible for them to contain anything embarrassing. Perhaps simply say that people with assets over $1 million must pay 35% of their net yearly increase in total wealth. Simple. 

So far, that leaves us with a larger deficit but with more money in the hands of the middle class. That’s good. We need larger deficits in the short term. But to deal with the longer term issues, the bill will also:

3)   Fix the long-term deficit – Index tax rates to economic growth. Make it so that once the economy improves, taxes automatically rise each year until the deficit is zero. By definition, closing the deficit this way doesn’t prolong the recession.

4)   Fix long-term entitlement growth – For people under 45, gradually increase the retirement age until outlays on Medicare and Social Security are equal to total payroll tax intake, and then index the retirement age to life expectancy going forward. To mitigate the impact on manual laborers and lower-income groups (whose life expectancy is increasing more slowly) allow people to apply for “retirement” disability benefits starting at age 60.

Overall, this plan stimulates the economy now while also fixing the long-term deficit.

It’s palatable to the Republicans: it incorporates elements of the Romney tax plan they’ve already publicly supported, it doesn’t raise tax rates, and it fixes entitlement spending.

It’s also palatable to the President: it leaves the rich paying more, it helps the economy, it does nothing to hurt the poor or middle class, it breaks none of his campaign promises, and it lets him appear magnanimous in victory.

Both parties advance their interests while claiming a victory for the spirit of bipartisanship (which is the only way anything will happen in Washington before 2014). And hopefully the bonhomie can carry into compromise on other issues.

It’s been pretty rare lately that the sensible economics line up with plausible politics. But now is one of those moments. This extremely simple plan would go a long way to fixing the major issues that have paralyzed Washington and the country for years.

[1] I no longer work at Bridgewater, and these opinions are entirely my own. 

[2] The numbers in this post are all very rough approximations. But with some calculation I’m pretty sure everything can be made to add up.

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