Battle lines being drawn in Washington over Bush-era tax cuts set to expire this year

Amid a contentious midterm election campaign, one of the sharpest divisions is over the expiration this year of Bush-era tax cuts, but almost everyone agrees on one point — doing nothing is not an option.

If Congress fails to act, taxes on most Americans would go up next year — adding $1,541 to the average household payment, by one estimate.

Taking that money, a total of $135 billion, out of the pockets of consumers and small businesses could be a devastating blow to the fragile economy.

FOR THE RECORD:
Tax chart: A chart accompanying an article in the Aug. 5 Business section about the expiration this year of Bush-era tax cuts contained incorrect information. The chart indicated that, under the Obama plan, couples filing jointly would fall into the 15% tax bracket for 2011 if their income was $17,151 to $58,200, and in the 25% tax bracket if from $58,201 to $140,600. The correct amount for the 15% tax bracket in that category is income between $17,151 and $69,700, and the 25% tax bracket is between $69,701 and $140,600. —

President Obama wants to avoid that. He proposes to continue the tax cuts for just about everybody. But he wants to let them expire for the most wealthy — families making more than $250,000 a year and individuals making more than $200,000 — to reduce the exploding budget deficit and fulfill a major campaign promise.

On Wednesday, Treasury Secretary Timothy F. Geithner hammered on the projected costs of continuing the tax cuts for top earners as the administration ramped up for a bruising fight.

“Borrowing to finance tax cuts for the top 2% would be a $700-billion fiscal mistake,” Geithner said in a Washington speech. “It’s not the prescription the economy needs right now, and the country can’t afford it.”

But Republicans appear united in wanting to extend all the tax cuts, providing a difficult obstacle in the Senate as it prepares to deal with the issue next month. And they’re being joined by some moderate Democrats, who worry that even Obama’s limited tax increase could derail the weak economic recovery.

“I think we’re at a point in our economic recovery that anything that would adversely affect it, we ought to avoid,” said Sen. Ben Nelson (D-Neb.), one of at least three moderates in the Senate who don’t want to see a tax increase next year, even one limited to the most wealthy.

The debate sets the stage for a high-stakes game of chicken, with the future of Americans’ wallets — and the economy — in the balance.

“If they don’t act, that would be a serious mistake and significantly raise the odds that the economy would unravel back into a recession,” said Mark Zandi, chief economist at Moody’s Economy.com.

Every American who pays federal income taxes would see them increase if the tax cuts expire, according to the nonpartisan Tax Foundation. A typical middle-class family with a median income of $63,366 would pay $4,964 in taxes next year if the cuts expire, well above the $3,423 tax it would pay if cuts were extended.

Congress doesn’t face an easy task. Even economists are split on what should happen to the temporary tax cuts championed by former President George W. Bush. Most were enacted in 2001 when the federal budget had a $128-billion surplus.

Some supporters of those tax cuts, including former Federal Reserve Chairman Alan Greenspan, want Congress to let all of them expire because of the soaring budget deficit.

“I am very much in favor of tax cuts, but not with borrowed money,” Greenspan said Sunday on NBC’s “Meet the Press.”

The White House has projected the deficit this year will be a record $1.47 trillion. Allowing all the tax cuts to expire would funnel about $3 trillion more into the Treasury over the next 10 years.

Other economists believe that with economic growth slowing as the economy continues to stumble out of the deepest downturn since the Great Depression, all the tax cuts should be extended — at least temporarily — to give consumers and businesses as much disposable income as possible.

“The top thing we need right now is growth and that should be the top priority,” said Douglas Holtz-Eakin, the former head of the Congressional Budget Office who served as the top economic advisor to the presidential campaign of Sen. John McCain (R-Ariz.). “There’s millions of people out of work in an economy that’s not growing that fast.”

That view is backed by business groups, such as the U.S. Chamber of Commerce, which warned that a return to previous tax rates would hamper new hiring. Republican congressional leaders have focused on that point, saying that half of small-business income would be hit with a tax increase under Obama’s plan.

“You cannot tax your way out of this problem,” Sen. Jon Kyl (R-Ariz.) said. “You need to grow. And in order to grow, you don’t raise taxes in the middle of an economic downturn.”

Geithner said the tax hike for the wealthy would affect only 3% of small businesses. Republican opponents, he said, apparently were including individual partners in law firms and principals in a financial institution in their calculation of small-business income.

With a Republican filibuster likely on Obama’s plan, some on Capitol Hill have begun talking about simply extending all the tax cuts for a year and renewing the debate when the economy might be stronger.

But Geithner strongly rejected that idea Wednesday, saying the world would see it “as a prelude to a long-term or permanent extension.” Such a view would undermine confidence that the U.S. is committed to addressing its long-term deficits, he said.

Federal Reserve Chairman Ben S. Bernanke highlighted the difficult choices in testimony last week during a House hearing. He acknowledged that tax cuts at any wage level helped stimulate the economy in the short term. But they also add to the growing budget deficit.

“Now that means that if you extend the tax cuts, you need to find other ways to offset them,” Bernanke said.

That’s a tall order. For most Democrats, the solution starts with ending the tax cuts for the top earners, letting them return to the 1990s level.

“That seems to me right now to make the best sense,” said Sen. Dianne Feinstein (D-Calif.), who is leaning toward Obama’s plan. Congress then could reassess the “middle-income tax cuts later on when the economy is in better shape,” she said.

Economist Zandi, acknowledging concerns about the deficit, said that endangering the recovery with a tax increase next year for the wealthiest Americans could do more damage than a temporary extension of those cuts. He favors phasing out the cuts for the top earners over two years, beginning in 2012.

“In all likelihood the recovery would remain intact with a tax increase on high-income households, but given the risks, I wouldn’t go down that path,” Zandi said.

jim.puzzanghera@latimes.com