Ignore the Bush Tax Cut Debate

As we noted in today's Business Breakfast, Treasury Sec. Tim Geithner said the White House isn't backing down from its campaign promise to extend the Bush tax cuts except for families earning more than $250,000, despite warnings from some economists that raising taxes on top of a slow recovery could hurt the economy.

Two years ago, this position might have seemed like a cinch. This year, it could be a dogfight. The Bush law is going to come up after the midterms, when Democrats will almost certainly lose a handful of Senate seats. What's more, moderate senators -- Bayh, Nelson and Conrad -- are already fleeing the administration and calling for extending the whole thing.

But the December Bush tax debate might not matter as much as we think. Before I explain why, let's consider what might actually happen at the end of this year.

There is absolutely, positively zero chance that the Bush tax cuts are going to be completely repealed. It looks great on paper to erase $3 trillion off our ten-year debt accumulation, but in the real world, a $300 billion/year stomach punch to the economy could turn a slowcovery into a double dip. On the one hand, I'm sympathetic to my colleague Megan McArdle's proposal: cancel them forever and replace with a one- or two-year tax that provides similar cover for the middle class. This would keep the Bush law from becoming an Eternal Extender -- always rewed and never reviewed by Congress -- and protect the fragile economy from a fiscal shock.

However appealing that solution appears, it's impossible. There's no way that a lame-duck Congress is going to find the time and energy to cancel the Bush tax cuts and write a payroll/income/cap gains law that achieves similar tax breaks. The more likely solution, which I also find acceptable, is to extend the Bush law for for one year and consider a more comprehensive tax overhaul in 2011. (Martin Feldstein calls for a two-year extension, but that only pushes a third-rail issue to an even more electric election year.)

But here's the thing: the White House expects to take on broader tax reform next year, as Geithner also noted yesterday. Tax reform on par with 1986 -- that is, something like the Wyden-Gregg proposal to lower rates and broaden the tax base by eliminating deductions -- is holistic. It touches on everything. 

So it doesn't particularly matter what Congress does with the Bush tax cuts in 2010's lame duck session. It particularly doesn't matter because Democrats won't have 60 Senate votes to get a head-start on raising marginal rates, so it's unlikely they'll do much of anything. The movers in Washington -- from the lobbyists to the legislative aides -- know that the real war over the tax code will be in 2011. Expect all sides to keep their ammo dry. December's Bush tax cut debate isn't the main event. It's the prelude.