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The inconvenient truth about the 'fiscal cliff' and 'taxing the rich'

As politics again looms as the primary obstacle to addressing the dreaded fiscal cliff, politicians will yet again surely be unable to resist the temptation to gain political support through sloganeering—think “taxing the rich,” “paying fair share”—than through the more difficult task of explaining basic economic principles.

Lost in the hoopla is that Mitt Romney favored an approach that would greatly increase the taxes on the rich by limiting deductions.

While proposing a reduction in the marginal tax rates for all, Romney’s proposed cap on deductions (say a limit of $50,000) would, according to the Tax Policy Center, inflict 96.2 percent of the resulting increase tax burden on the top 20 percent of income earners, and 79.9 percent of the increased higher tax revenues on the top 1 percent.

Meanwhile, the simplistic idea of raising the marginal tax rates on the rich by a couple of percentage points without limiting deductions would simply redirect the rich to their expensive tax lawyers to create non-productive tax shelters (such as digging holes and then filling them up), or to the use of such obvious loopholes as tax-free municipal bond income—which is what happened in the 1950s when the tax rates on the rich exceeded 90 percent.

Politicians will never give up the game of handing out tax deductions to special interest groups in exchange for campaign contributions.

Indeed, it was not until 1962 when President John Kennedy recognized the damage that such marginal rates did to the economy and jobs, and dramatically lowered the marginal rates that the economy began to pick up. Although the epithet of “Tea Party” did not exist in 1962, had the term existed it would doubtless have been applied to Kennedy for recognizing that a rising tide lifts all ships.

Likewise, when Reagan inherited an economy that Jimmy Carter had left with 10.6 percent unemployment, double digit interest rates, and inflation of 20 percent, he did not blame the previous administration (as a more recent president as been wont to do), but instead got down to work and lowered marginal tax rates and reduced deductions. The result was that by the end of his term the economy was roaring at 6.2 percent, unemployment was cut almost in half, and America was on its way to eight years of sustained economic growth.

If the demagogues were really serious about raising revenues from the rich, they would expose the myth that the home mortgage deduction is a “middle class” deduction. In fact, the inconvenient truth is that the bottom third of Americans reap nothing from the deduction, and half of the remaining 65 percent can’t use it because the standard deduction is more favorable. And of the top 35 percent who do actually use it, the lion’s share goes to the very richest homeowners who can afford, and thus deduct, the interest on—believe it or not-- a million dollar mortgage. No other country in the world rewards its very richest homeowners with largess on such a magnitude.

It is, of course, easy to envy the movie stars who earn millions and live in multi-million dollars palaces, but it is they who in California are showered with property tax protections on palaces bought before 1978, while the hapless “Great Unwashed” are taxed into oblivion or forced to leave the state to survive.

The obvious compromise to avoid the fiscal cliff would be to raise revenues from the rich by adopting Romney’s plan to lower marginal rates and limit deductions to $50,000—which is exactly why it won’t happen. As the “realists” point out, politicians will never give up the game of handing out tax deductions to special interest groups in exchange for campaign contributions.

Robert Hardaway is Professor of Law at the University of Denver Sturm College of Law, author of "The Great American Housing Bubble" (ABC-CLIO, 2011), and eighteen other books on law and public policy.