WASHINGTON (MarketWatch) – Now that Republicans have conceded two of their most cherished economic ideals, the path is open for them to reach a deal with President Barack Obama to avoid going over the so-called fiscal cliff in early January.

The only thing that stands in the way of a deal now is for the Republicans to recognize that they’ve already given up on their core principles.

President Barack Obama campaigns for higher taxes on the rich at the Daimler Detroit Diesel plant in Redford, Mich., on Monday. Reuters

Foremost, they’ve now agreed to raise taxes on the wealthy, thus abandoning their No. 1 talking point that taxes can never go up. Read Republicans offer tax revenue in cliff plan.

And, just by acknowledging that the fiscal cliff has to be avoided because of the damage that austerity would inflict on the economy, they’ve rotated 180 degrees to become Keynesians in their economics, thus abandoning their main gripe about Barack Obama’s efforts to stimulate the economy over the past four years. Read John Boehner describe “the threat to our economy” from the fiscal cliff.

It could take some time for Republicans to realize what they’ve done, and it could require some tricky negotiations to allow both parties to save some face in a final bargain. It is by no means certain that a deal can be struck by Dec. 31. But the biggest hurdle to a deal has now been overcome.

Republicans insist that they are still standing by their principles. But that’s just political posturing.

Everything you need to know about the fiscal cliff

The key concession by the Republicans was when House Speaker John Boehner agreed to $800 billion in new revenues, rather than $0. We don’t know the details of the Republican proposal; all we know is that the money would come from reducing various tax breaks for families making over $250,000, but we don’t know which ones would be capped or eliminated.

Obama is on board with reducing some of these tax breaks, but he says that it wouldn’t raise enough money. Obama insists that marginal rates must rise, while Republicans insist that they must not.

There doesn’t appear to be much common ground in those two positions, and neither side has budged an inch on that particular demand.

Of course, there are plenty of other issues that also must be resolved in the fiscal cliff negotiations, including how much to trim spending on Medicare and Medicaid and other government programs. However, both sides have some negotiating room on spending; they haven’t drawn too many lines in the sand. The intractable issue is what to do about marginal rates. Solve that, and everything else will fall into place.

There is less than meets the eye in the disagreement over marginal tax rates. In terms of economic impact, it won’t make that much difference how the extra revenue is raised, whether by raising marginal tax rates or through broadening the tax base by eliminating some tax deductions and exclusions.

In either case, the money will come from the very few who make more than $250,000 a year. That’s what Obama campaigned on and it looks like he’ll get what he wanted.

Broadening the base

Conservatives and liberals alike argue that “broadening the tax base” is theoretically the best way to raise more revenue. These tax breaks — also known as tax expenditures — distort economic decisions. They give people incentives, for instance, to invest more in housing or spend more on health care than they would otherwise.

Fiscal cliff talks: Who blinks first?

We could improve the economy’s efficiency (thus creating jobs and raising output) if we got rid of the distortions, economic theory suggests. The problem is that these tax breaks exist because they have powerful constituencies and powerful political friends. Limiting or abolishing tax breaks isn’t easy, or it would have been done already.

We shouldn’t overestimate how much economic boost we’d get from broadening the tax base, particularly from one that is designed to raise revenue. The 1986 tax reform, a much more comprehensive reform than anything currently being contemplated, had almost no discernible impact on long-term economic growth, employment or productivity, economists have found. Read a review of the Tax Reform Act of 1986 from Bruce Bartlett.

Marginal rates

On the other hand, conservatives often argue that an increase in the marginal rate (the tax paid on the last dollar earned) can have a large impact on the incentives to work or to save.

For instance, someone in the top bracket may decide not to put in extra hours of work if they can only keep 60 cents out of each additional dollar of income, rather than 65 cents under the old tax rates. They may refuse to save and invest if the interest, dividends and other income from those savings are taxed too much.

At least, that’s the theory. Empirical studies have found that the economic disincentives from higher marginal rates are actually relatively small; most people don’t reduce their work hours or savings very much in response to an increase in the marginal rate. What they do in response is to shield more of their income from the taxman, for instance, by converting ordinary income into forms that are lightly taxed, such as capital gains or dividends. Read an overview of the research on marginal tax rates.

The nonpartisan Congressional Budget Office concluded that raising the marginal rate on the top 2% of earners wouldn’t have much impact on the economy over the next year; it would reduce gross domestic product by just 0.1%. By contrast, ending the payroll tax holiday and letting extended unemployment benefits expire would cut GDP by 0.7% and would hit the pocketbook of most American families. Read the CBO’s report on the fiscal cliff.

The economic evidence suggests that it won’t matter very much to the economy which way the politicians choose to raise more revenue, as long as they get a deal done early in the year.

The political impact of their choices will be a different matter. One side or the other still must swallow something very bitter.