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What's the Policy Rationale Behind Plan B?

By Josh Barro
December 19, 2012 4:09 PM EST

As of a couple of months ago, Republicans' position in fiscal cliff negotiations was simple: No higher tax rates on anybody. And the rationale, agree with it or not, was clear: Higher tax rates reduce incentives for work and investment, and therefore gross domestic product growth.

Now, Republicans have moved on to "Plan B": An increase in marginal tax rates, but only for incomes over $1 million a year. The political rationale is clear. Republicans can't get everything they want on the tax issue and don't want to be portrayed as "holding America hostage for tax cuts to millionaires."

The policy case for Plan B is much less clear. After all, it involves the same increase in the top tax rates on both ordinary income (from 35 to 39.6 percent) and on capital gains (from 15 to 20 percent) as President Barack Obama's proposal to end the Bush tax cuts for people making over $250,000, yet it doesn't raise as much money.

If higher marginal tax rates are such a problem, why is Plan B any better than the president's original proposal? Here are three possible cases, none of which I think are very convincing:

1. Plan B does hold down marginal tax rates for taxpayers earning between $250,000 and $1 million.

So, it might encourage more savings and investment than the Obama plan does.

But, as Republicans are fond of noting, investment is heavily concentrated on the top; if the top tax rate is a big deal for the economy as a whole, whether it starts at $250,000 or $1 million probably isn't very important. Also, the tax policy environment remains unstable, so even if Plan B becomes law, taxpayers in the $250,000 to $1 million band won't have much confidence that their rates will stay low for years to come -- dampening any encouragement to invest.

2. As Paul Ryan says, Plan B will "protect as many Americans as possible from tax hikes."

This is closely related to point (1), but aside from the incentives issue, it also picks up the idea that preventing tax increases is a matter of fairness. Does that really apply, though, to families earning over $250,000? Should I be concerned that a tax increase would put a strain on their personal finances, aside from any effects on the broader economy?

3. Plan B will raise less tax revenue than the president's plan.

If your goal is to "starve the beast," this can be viewed as a feature. On the other hand, if you're concerned about long term deficits, it's a bug.

The low revenues are especially perverse because Plan B is a modest tax increase, but one that is designed to impose unusually high economic costs per dollar of revenue, because it operates by raising already-high marginal rates at the top and raising taxes on capital.

As the cliff negotiations started, Republicans were talking up base broadening as a way to raise a little revenue without hurting the economy. Plan B is essentially the opposite approach: a little more revenue, with as little economic efficiency as possible.

The proposal is also frustrating because it takes President Obama's already-silly red line about who can be asked to pay more taxes and moves it even higher. At this rate, the ever-shrinking cohort of Americans who are rich enough to be expected to pay more taxes may be reduced within a few years to just Warren Buffett personally.

Obviously Republicans needed to meet the president in the middle somewhere. I would have rather seen them push for a deal that went to a top rate somewhere above 35 and below 39.6, and between 15 and 20 on capital gains.

But if Republicans have determined they must agree to the same top rates the president wants, they might as well cave on the $250,000 threshold too, take the extra revenue to further reduce the budget deficit and save their political capital for tax reforms that might actually grow the economy.

(Josh Barro is lead writer for the Ticker. E-mail him and follow him on Twitter.)

Read more breaking commentary from Bloomberg View at the Ticker.

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