A Compromise for the Tax Cut Debate

The debate about whether to extend the Bush tax cuts just for the middle class and whether to make the extension temporary or permanent couldn’t be more important. A permanent extension of most or all of them is unaffordable, given looming deficits. But allowing all the tax cuts to expire, given the state of the economy, is unwise.

What to do? President Barack Obama wants to make the middle-class tax cuts permanent. Republicans also want to make the cuts permanent — but for everyone, including the wealthy. Peter Orszag, former Office of Management and Budget director, suggested a compromise: Extend them for everyone, but only temporarily.

The Orszag plan deserves consideration — if it can be enacted. The problem is that temporary cuts almost always get extended.

So Orszag’s plan may just postpone the decision. And it continues expensive tax provisions that mainly benefit the top 2 percent of the population.

It’s worth considering some alternatives.

The president can keep his promise to the middle class not to raise income tax rates, but he should offset the costs after 2012 by broadening and simplifying the tax base. He has to ensure that the Bush tax cut extension is revenue neutral by 2013 and has to begin to bring in additional revenues over that decade and beyond.

The simplest way to do this is to cap the value of various deductions and then keep them capped in a way that ensures more federal revenue over time. He must also begin to address the explosion of debt caused by the aging of baby boomers and rising health care costs after about 2015.

This proposal needs to be made and passed now. Such caps are likely to be fiercely resisted, but the alternative — a deficit-ballooning extension of the Bush tax cuts — is fiscally irresponsible. By eliminating hidden subsidies that are, in effect, backdoor spending programs, this proposal would also make the entire tax system simpler, more efficient and more pro-growth.

What about the wealthy? Instead of extending their tax cuts, let’s give them a big, but temporary, incentive to spend not only their incomes but some of their wealth — thereby providing jobs for everyone else.

One way to do this is a temporary tax break for contributions to nonprofit organizations over the next two years. Imagine what would happen if we doubled the value of making a charitable contribution by providing a deduction worth twice the taxpayer’s normal tax rate. For the top two brackets, tax rates would revert to pre-2001 levels, but roughly 75 percent to 80 percent of any contribution would be tax deductible in 2011 and 2012.

This could create a huge incentive to give to charity now rather than later, helping to stimulate the economy. Charitable organizations employ one out of every 10 workers in the economy and most quickly spend or give away the money they receive.

These organizations vary enormously — from those that support the arts, education and health to those that provide assistance to the poor or to local communities. Faith-based organizations also garner a hefty portion — a fact that should appeal to many on the conservative side of the spectrum.

All these organizations competing for the new dollars could ensure that the money was being well-spent — in line with public preferences, not according to bureaucratic dictates in Washington.

With this proposal, Obama could argue that he was providing a new, if temporary, benefit tilted toward high-income households, while encouraging them to spend the money in socially productive ways; that he was not reneging on his commitment to keep middle-class tax rates at current levels; and that he was making a serious down payment on reducing the deficit and cleaning up our overly complex and inefficient tax code.

It should be up to Republicans to support the plan or come up with their own. In the madness leading up to the midterm elections, it may not be possible to get much action on this. But both sides may be open to some compromise during a lame-duck session of Congress.

The bottom line? We need some short-term stimulus, but we cannot afford to extend the Bush tax cuts unless we simultaneously deal with looming deficits.