The Republican Tax Panic: The GOP should negotiate with Obama, not each other.

WSJ, Editorial

If any Republicans thought that President Obama would respond with magnanimity in victory, they now know better. He is determined to rout them on taxes, give as a little as possible on spending, and blame them for any economic damage in the bargain. The question for the GOP is how to minimize the harm to the economy, as well as to their chances of a political and policy comeback in 2014 and beyond.

So it’s a shame that Republicans are playing into Mr. Obama’s hands, negotiating in public among themselves, prematurely giving up on the tax issue and undermining House Speaker John Boehner in the process. Mr. Obama isn’t going to blink on the budget if he thinks Republicans are going to blink first, and so far the emerging GOP position seems to be to surrender on taxes first and hope Mr. Obama will have mercy on them later on entitlements.

Tennessee Senator Bob Corker made the case for this strategic retreat on “Fox News Sunday,” arguing that if Republicans raise tax rates as Mr. Obama wants, “the focus then shifts to entitlements and maybe it puts us in a place where we actually can do something that really saves the nation.”

But what is the evidence in the last four years, or even since the election, that Mr. Obama won’t pocket that victory and then refuse to offer any but token changes on entitlements? Mr. Corker has proposed several specific and laudable entitlement changes, but note how Mr. Obama has declined to support a single one of them in public. After he has GOP fingerprints on tax rate increases, Mr. Obama is more likely to make Republicans trade onerous defense cuts for entitlement changes that are far less consequential than Mr. Corker has proposed.

There are also the economic merits to consider, if that doesn’t rudely intrude on all the political calculations. Republicans presumably campaigned against raising tax rates because they believed what they said about the costs to growth and small business. The economic evidence is overwhelming that they are right.

But now various Beltway sages want Republicans to say never mind, we were only kidding, tax rates don’t matter to the economy. So because Mitt Romney lost, Republicans in Congress are supposed to repudiate their core economic principles.

Mr. Obama says he merely wants tax rates to return to the “Clinton rates,” but rates are already scheduled to go higher than that thanks to ObamaCare. There’s the 0.9% Medicare surcharge on all income above $250,000, plus the 3.8% surcharge on investment income. The U.S. economy in 1993 also had far more growth momentum than it does today.

Bill Clinton agreed to cut the capital gains rate to 20% in 1997 but Mr. Obama wants it to be 23.8% at least. State tax rates are also higher than they were in the 1990s, especially in California, where the capital gains rate now is 13.3% on top of the federal rate. Combined that would be 37.1%. In Singapore, the capital gains tax is . . . zero.

Mr. Boehner’s offer to raise revenue by reducing loopholes and deductions is therefore the right policy direction and consistent with a pro-growth tax reform. If Mr. Obama were open to a tax reform that reduced rates in return for fewer deductions, Republicans would be right to make a down payment this year and negotiate a larger reform in 2013. That is why we have supported raising revenue by closing loopholes, which are exploited the most by the richest Americans.

The problem is that Mr. Obama has backtracked on reform. In 2011 he was saying he wanted $800 billion in more revenue, and that he and the GOP could get it from deductions. Now he says he wants higher rates and fewer deductions in order to raise $1.6 trillion in more revenue over 10 years. He may also believe it’s a concession to raise the top tax rate to 37% or 38% (from 35%) instead of the 39.6% Clinton rate as long as he also gets more revenue from capping deductions.

This latter choice would be the worst possible deal for the economy and for Republicans. Not only would they have agreed to raise rates, but they’d have given away the revenue from deductions that could be traded for lower rates. This wouldn’t be a step toward tax reform but a double-barreled tax increase. And it would make a genuine pro-growth tax reform all but impossible.

It’s certainly true that Republicans can’t stop a tax rate increase if Mr. Obama is determined to make it happen. The Bush-era rates automatically go up on January 1, and the House can’t extend them alone.

But Mr. Obama also can’t get what he wants without House Republicans. He needs their votes to extend current rates for lower-income taxpayers, as well as to prevent the Alternative Minimum Tax from hitting 27 million more taxpayers. Most of those new AMT taxpayers live in high-tax Democratic states. Meanwhile, the death tax rate reverts to 55% and a $1 million exemption. Senate Democrats running for re-election in 2014 won’t want that on their resume.

For all of his bluster about blaming Republicans, Mr. Obama also knows a budget failure would do enormous harm to his chances of second-term success. It would guarantee at least two more years of trench budget warfare and poison the chances of immigration or other reform. Another recession would be on his watch, not on George W. Bush’s.

The point is that Republicans have more leverage than they imagine, and they ought to act like it. A good start would be for the House to pass a bill this week extending all the tax rates for six months and fixing the defense spending cuts coming in January. Then ask Senate Democrats to pass their own bill, and they can negotiate with the President under regular Congressional order.

At the same time, Mr. Boehner could alert his new Members that he’ll convene the next House to pass the same bill again on January 3. The world doesn’t end on December 31 and the law can still be changed. Such resolve would show some leadership and demonstrate to Mr. Obama that Republicans are prepared to let the spending sequester begin to take place if he won’t negotiate over spending in good faith.

Mr. Boehner and Republicans can also make clear to the voters that if Mr. Obama doesn’t want to jump off the “fiscal cliff,” he can always instruct the IRS not to change the tax withholding tables pending further negotiations. And he can instruct his budget office to instruct the Pentagon to exercise flexibility in the way that it implements the automatic spending cuts.

Mr. Obama wants to give the appearance of a looming fiscal crisis because it serves his political interest in spooking Republicans to give him everything he wants. He’s pressing so hard for tax rate increases not because they will bring in much revenue but because he wants GOP tax cover for Democrats in 2014 and to get Republicans to concede that tax rates must rise. Once he pockets that, he’ll be back by more.

Republicans need not play along, and they and the country will suffer if they do. Above all, they need to start negotiating as a team with Mr. Obama and stop making premature concessions for the TV cameras that only make the White House less likely to meet them half way.

A version of this article appeared December 10, 2012, on page A20 in the U.S. edition of The Wall Street Journal, with the headline: The Republican Tax Panic.

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