Six Ways President Obama and Congress Can Avoid the “Fiscal Cliff”

Republican congressional leaders and President Obama sharply disagree over how to deal with the impending “fiscal cliff.” Negotiations among Democratic and GOP lawmakers will be tough. But averting the cliff and putting the nation on a sustainable fiscal course shouldn’t be that hard.

A reasonable framework could be agreed to now, with the details worked out in 2013. Such a scenario includes a balance of spending cuts and new revenues, most of which are consistent with the recommendations of a variety of bipartisan groups and priorities articulated in the recent election.

Here are six ways Washington can avoid the “fiscal cliff.”

1. Extend all tax cuts except those for millionaires

President Obama and Congress must first extend all of the Bush-era tax cuts except those affecting millionaires. Individuals and small businesses with annual incomes of more than $1 million can afford to pay a little more.

Those with incomes above $250,000 can also afford to pay a little more, but Mr. Obama should be willing to extend their tax breaks. Compromise demands a little give here on a Republican priority. Democrats will like that the truly wealthy will be required to pay higher taxes, while Republicans should like the fact that most of the Bush tax cuts are extended.

2. Fix the Alternative Minimum Tax and cap deductions for the wealthy

Everyone agrees Congress should fix the Alternative Minimum Tax. It originally applied to wealthy earners to limit deductions and expand taxable income, but because it hasn’t been adequately adjusted for inflation, more and more middle class families are being affected by it as well.

In addition, we should cap deductions for those with incomes above $250,000, either with a hard dollar cap such as $35,000 or at a 28 percent rate. At a 28 percent rate, a $1,000 deduction that would normally reduce one’s tax bill by $350 would instead be worth a little less: $280.

This limits backdoor spending through the tax code but doesn’t threaten any particular deduction. It raises revenues from the wealthy, a key Democratic priority, without raising rates.

Congress and Obama should agree to enact these two tax provisions now but implement them in 2014 so as not to undermine a fragile recovery. 

3. Cap federal health-care spending

Washington should strengthen the Affordable Care Act provision that calls for the growth of Medicare spending per capita to be no faster than the growth of GDP plus 1 percent. As part of the push to curb health-care spending, lawmakers should also redouble efforts to improve the delivery of care so that Americans get better value for their health-care dollars.

They might call for a value-added or national sales tax earmarked for health care if the cap on federal spending is exceeded at the end of the decade. In the end America can only have the health care it is willing to pay for.

4. Raise retirement age and use means testing for Social Security and Medicare

To rein in entitlement liabilities, Congress should gradually raise the retirement age for both Social Security and Medicare. This should include an exception for those who have worked in physically demanding jobs or whose lifetime earnings have been low. Policymakers can also use means testing, asking more affluent seniors to pay higher premiums or accept less growth in their Social Security benefits down the road.

As part of these reforms, Washington could also update cost-of-living adjustments for both taxes and spending to more accurately reflect inflation. Democrats should like the fact that lower-income seniors are protected, while Republicans should be pleased with these efforts at entitlement reform.

5. Replace sequester spending cuts with more sensible reforms

The 2011 Budget Control Act dictates automatic – and devastating – spending cuts of $1.2 trillion that will take effect beginning next year unless Congress and the president take action to avert this sequester. Congress should vote to repeal the sequester and replace the cuts with more sensible ones, such as limiting farm subsidies and reining in health-care costs more.

Discretionary spending has already taken a big hit and is not the primary source of our fiscal problem. Reallocations and reforms within this category are needed, but current levels of already-capped spending are barely sufficient to keep the country strong, both militarily and domestically. Domestic spending programs such as education, infrastructure, research, and those targeted at lower-income families should be preserved.

Democrats will be pleased these programs are spared from drastic cuts, while the GOP will be relieved that the defense budget can avoid the sequester’s ill-considered ax.

6. Eliminate the statue that requires Congress to approve debt-ceiling increases

To avoid another dangerous debt-ceiling showdown, lawmakers need to repeal the statute that requires Congress to approve increases in the debt ceiling. They should replace it with a provision that requires automatic across-the-board spending cuts whenever spending exceeds the historical average of about 20 percent of GDP. That figure should also be adjusted by the Congressional Budget Office for demographic and economic trends that no one can control and for allowable increases in health-care spending.

This ensures that spending is kept under control, but recognizes that an aging population is going to necessitate that spending on seniors rise somewhat if we are to prevent the kind of damaging cuts to other programs that undermine economic growth and societal well-being.

The public is willing to pay higher taxes but only if they are assured that these are needed to reduce the deficit, not pay for a much bigger government. And placing limits on spending is a top GOP priority.

Eliminating the debt-ceiling rule is critical to allowing both parties to move forward without worrying about a new crisis every time the current ceiling expires. Leaving this vehicle in place just guarantees more car wrecks down the road. The current debt statute is an anachronism. Its primary function is not to rein in spending – since this is spending that Congress has already authorized – but rather to hold the economy hostage to one party’s demands.

Whatever the fiscal cliff’s economic consequences, they are not nearly as bad as a default on our debt.