New York Mayor Michael Bloomberg has proposed a sensible way forward with an Op Ed column, “Avoid the ‘Cliff,’ Restore the Confidence” in the December 12, 2012 edition of the Washington Post . His thesis is that businesses took on too much risk in the run up to the 2008 crash but now they are sitting on hordes of cash because they lack confidence that our political leaders can come up with a serious, credible plan to reduce the deficit and put our country on a sustainable path to economic growth and fiscal health.

His proposal for accomplishing this task is remarkably similar to that outlined by David Walker and discussed in my previous post on December 10, 2012.  That is, we should adopt the Simpson-Bowles framework, including tax increases and spending cuts.  At least a significant down payment on this plan should be agreed to before the end of the year.  The agreement would include a commitment to enact broader-based tax reform and entitlement reforms in 2013.

With trillion dollar deficits for four years in a row, now going on five, we definitely need more tax revenue as well as large spending cuts.  The biggest challenge in implementing this general framework is to figure out how to raise tax revenue in the least damaging way to the economy.

The tradeoff here is between raising tax rates versus eliminating tax deductions and loopholes.  Democrats (apparently) prefer raising tax rates rather than eliminating deductions.  This is unfortunate since it is well established in economic theory, as well as plain common sense, that the lowest possible marginal tax rates will provide the greatest stimulus to private risk taking and investment. This is the only sound way to create more jobs.

Democrats may have the strongest political position in the current negotiations but the Republicans have the soundest basic economic principles.  If the Republicans are able to keep the focus on the fundamentals, we will succeed in finding the way out of our current predicament.