WASHINGTON — With the clock ticking toward a massive, automatic tax increase at the end of this year, President Barack Obama on Monday will launch a political battle over who will pay higher taxes and who won't.
Without action, all the Bush-era tax cuts that were enacted in 2001 and 2003 will expire on Dec. 31.
The $1,000-per-child tax credit will drop to $500 per child. Income tax rates will increase for all taxpayers. All taxes on capital gains, dividends and estates will rise.
With his budget proposal Monday, Obama will urge Congress to extend all of the Bush-era tax cuts for those who make less than $250,000 a year and to end those cuts for everyone who makes more than that, as he promised in his campaign.
Yet times have changed radically since he first vowed the tax changes.
Now, soaring federal budget deficits make the prospect of adding trillions more to the debt to sustain the tax cuts more perilous to the economy — and politically.
Anxiety over what so far is a jobless recovery from the worst recession since the Great Depression is driving even some of Obama's fellow Democrats to say that any tax increase now — even on the wealthy — could choke off a wobbly recovery.
Thus, the results of the coming debate will determine not just how much people pay in taxes next year, but also could have outsized impact on the federal budget and the economy for years to come.
The first challenge is to make the tax cuts permanent for those who make less than $250,000. Normally a politically easy thing to do — and it likely will remain so this year — the move nonetheless would add to the already soaring federal deficit and could put a drag on the economy later.
Extending those cuts — along with another fix to the Alternative Minimum Tax to make sure those people don't get socked with a tax increase — would add as much as $3 trillion to the deficit over the next 10 years, according to figures from the Office of Management and Budget, as well as the Concord Coalition, an independent, bipartisan anti-deficit group.
At the same time, it's unlikely that the government will offset the lost tax revenues with spending cuts. The Senate on Thursday voted for new budget rules requiring that any new tax cuts or spending increases be paid for with offsetting tax increases or spending cuts to ensure that deficits don't rise — but specifically exempted the cost of making the Bush-era middle class tax cuts permanent.
Ironically, one of the top White House officials writing the plan to extend the tax cuts argued a few years ago that such a move without offsetting cuts in spending would hurt the economy in the long run.
Peter Orszag, who's now the director of the White House Office of Management and Budget, co-authored a 2004 paper while at the Brookings Institution, a center-left Washington policy group, saying that making all of the Bush tax cuts permanent would create a "fiscal drag" on the economy.
"Making the tax cuts permanent would raise the deficit over the medium term in the absence of any offsetting revenue increases or spending cuts," Orszag and William Gale said in the paper. "The increase in the deficit will reduce national saving and with it, the capital stock owned by Americans and future national income."
While Orszag's 2004 paper assumed that all the Bush era tax cuts would be permanent, the same logic for his conclusion applies to Obama's proposal to make permanent only the tax cuts for people earning under $250,000 — for as OMB and the Concord Coalition conclude, that alone would add $3 trillion to the deficit over 10 years.
Orszag's office didn't respond to requests for comment.
Maintaining the tax cuts without any way to replace the revenue to the government and no offsetting cuts in spending would force the government to borrow more, likely from China and other foreign countries. That could drive up interest rates, crowd out other federal spending or force tax increases.
"We're mortgaging part of our future and mortgaging future income," said Robert Bixby, the director of the Concord Coalition. "We'll be doing less investing, which means slower growth long term."
Obama faces other challenges in his quest to let the tax cuts expire for everyone who makes more than $250,000.
He's promised that ever since his campaign. With Americans still looking for a robust rebound from a staggering recession, however, many Republicans and some Democrats fear that the tax increase on the wealthy would inhibit a recovery.
"Allowing the 2001 and 2003 tax rates to expire at the end of 2010 before our economy fully recovers may significantly hinder job growth," said Rep. Michael McMahon, D-N.Y., in a draft letter to Obama he is circulating among other members of the House of Representatives.
"There is a certain logic to leaving well-enough alone for now, given the fragility of the economic recovery," said Rep. Gerry Connolly, D-Va. "It's a question of prudent judgment and timing."
If the tax increases might dampen the recovery, the cost of keeping those tax cuts also would have a downside.
Keeping all of the Bush tax cuts without offsetting spending cuts would add $4.5 trillion to the deficit over the next 10 years, said Congressional Budget Office Director Douglas Elmendorf.
That could push the federal debt past a potential tipping point toward economic calamity.
The federal debt now adds up to about 60 percent of one year's gross domestic product, the value of all U.S. goods and services produced. If all of the Bush tax cuts were made permanent, the debt by 2020 would total 87 percent of GDP and would be rising rapidly.
"Debt poses a risk of some more cataclysmic event in which investors might decide that they were not willing to hold Treasury debt at anything like the current interest rates or became unwilling to hold U.S. dollar assets in the way they have at this point," Elmendorf told Congress this week.
"Whether there is a tipping point, and if so, at what level of debt relative to GDP it would occur, we just don't know."
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