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One Cheer for the 'Cliff' Deal

One cheer out of a potential three is all anyone can logically give the "fiscal cliff" deal. On the day after the bargain was clinched, the stock market gave a 300-point cheer. So be it.

In the short run, extending tax cuts up to $450,000 probably saved us from a recession. If all the tax cuts had expired, we'd have a $500 billion tax hike, plus marginal rate increases, and that would have sunk the economy. So I'm going to bet that the big stock rally was a sign of relief that the final deal wasn't worse.

The final product was sort of a least-bad tax scenario. The top tax threshold got to $450,000. Capital gains and dividends were capped at 20 percent. And even the estate tax did better than feared, with a 40 percent rate off a $5 million exemption. Plus, all the tax rates were made permanent—including the rate for the alternative minimum tax (AMT). (Read More: What 'Fiscal Cliff' Deal Means for Those Paying AMT.)

So it could have been worse. And it probably saved a recession. So that's the one cheer. But the rest of this story goes from bad to worse.

Let's start with no spending cuts. The spending sequester was thrown out the window. And I have zero confidence that much if any of it will be restored in the next couple of months. The well-publicized ratio of 41-to-1—tax hikes over spending cuts—is deplorable.

We'll see during the upcoming debt-ceiling battle whether Congress, including the Republicans, has a real appetite to cut spending. There will be talk about shutting down the government, and even worse talk of a debt default. But right now it's hard to expect any consensus on real entitlement reform and spending restraint that would limit the federal share of the economy to 20 percent, which is where it belongs.

Daniel Acker | Bloomberg | Getty Images

And that brings me back to the tax problem. President Barack Obama is going to want another $600 billion or $700 billion in tax hikes. The recent bill already curbs high-end exemptions and deductions. But get ready—more is on the way from Team Obama. More deduction caps. Maybe a value-added tax. Maybe a carbon tax. Or maybe they just keep taxing the rich.

(Read More: For Taxpayers Making More Than $250,000, a New Math.)

And don't forget the Obamacare tax hikes, which are estimated to be roughly $1 trillion over the next ten years. That includes a 3.8 percent surtax on investment income above $250,000 per family, a 0.9 percent hike in the Medicare payroll tax (also a $250,000 threshold), a 2.3 percent medical-device tax, new caps on flexible health accounts, and an Obamacare haircut for medical itemized deductions.

In rough terms, when you add the Obamacare tax hikes on successful investors, earners, and small-business owners to the new fiscal-cliff bill, you're looking at a roughly 12 percent decline of incentive rewards from lower profitability and less take-home pay.

(Read More: Despite Cliff, US Will 'Soon Get Messy' Again: Roubini.)

Of course this is anti-growth. Of course this will reduce the long-term growth potential of the U.S. economy. And of course the added revenues will be spent, bloating the budget and reducing the economy's potential to grow.

It's a European economic model. And it's the exact reverse of supply-side economics. You can't tax your way into prosperity or a balanced budget. The economic pie grows smaller. Government grows bigger. Redistribution and government dependency grow more powerful and pervasive.

(Read More: For Obama, 'Cliff' Victory Also Holds Risks.)

And make no mistake about this: Economic growth is the key to reducing the spending, deficit, and debt share of the economy. Specifically, grow the GDP denominator with real personal and corporate tax-rate reform and reduce the demand for government dependency. That's the solution to our problem. A 20 percent spending rule would cure the problem even faster.

Unfortunately, we're going in the wrong direction right now.

—By CNBC's Larry Kudlow; Follow him on Twitter @larry_kudlow

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