By Vicki Needham - 11/01/10 10:00 AM EDT
Congressional inertia on the George W. Bush-era tax cuts could push action into January, setting up the first face-off on a major issue between Republicans and Democrats in the new year.
A day before the midterm elections and two weeks before lawmakers return to Washington for a lame-duck session, two leading theories have emerged on what will happen on tax cuts — either all of them will be extended for at least a year, or nothing will happen.
Obama has been firm in his stance that tax cuts for those in higher income brackets, those making more than $250,000 a year or more, should be allowed to expire at the end of the year, while middle-class tax breaks are extended.
Meanwhile, Republicans and some Democrats have backed a plan to extend all of the tax cuts while the economy recovers from the recession.
West Virginia Senate candidate Gov. Joe Manchin (D) and Delaware's Chris Coons (D), both of whom would join the Senate immediately if elected Tuesday, have said they prefer an extension of all tax cuts, leaving their party well short of the 60 needed to advance a bill that addresses extending only middle-class tax cuts.
Sen. Robert Menendez (D-N.J.) suggested Sunday that he may be willing to support an extension of all Bush-era tax cuts but ruled out the idea of making them permanent for those in higher tax brackets because of the cost.
"I certainly believe that there may be some opportunity for a temporary approval of some of these cuts," Menendez said on ABC's "This Week."
"You can't talk about spending and being responsible on spending and then spend $4 trillion that you don't have of our collective wealth to the individuals who have the greatest wealth in the country."
Making all the tax cuts permanent would add nearly $4 trillion to the national debt over the next 10 years. Allowing tax cuts for those in the upper brackets to expire would knock about $700 billion off that amount.
Whatever the decision, there are big policy and political implications across the board.
"They will try to do as little as possible," said Jim Kessler, vice president for policy at Third Way.
He is predicting that President Obama will win on the higher income tax brackets, with Congress letting those rates rise to Clinton-era levels while keeping middle-class tax cuts in place. Republicans would get their victory by ensuring capital gains and dividend rates don't change.
Kessler's scenario is likely one of the more optimistic, as neither party appears prepared to budge.
The White House also could call for a vote on a short-term extension of the tax cuts for higher earners, which includes some businesses, setting up another vote in a year or two and putting Republicans on the defensive to vote for another extension, according to news reports.
Leadership in both parties from the Capitol to the White House could provide a quick indication after the election as to whether they are willing to make some concessions or if they will continue with the familiar rhetoric that has dominated the midterm elections.
The biggest problem they face is that letting tax cuts linger into the new year without any concessions from either side will leave individuals and businesses bogged down amid continued economic and political uncertainty that could stunt economic growth, Kessler said.
So that means the best time for a clean extension of all rates, even if only for one year, is before Thanksgiving, said Pete Sepp, vice president for communications, National Taxpayers Union.
Holding off until December increases the chance that lawmakers will punt the issue into the 112th Congress, holding up withholding tables that will make the process all the more onerous because "other end-of-year processes like holiday bonuses, health insurance enrollments will be occupying payroll administrators and employers," Sepp said.
Although the deficit is an issue for lawmakers, the financial markets aren't concerned with the deficit. Instead, the market would be fueled by any signs of cooperation between the White House and Congress, Cannally said.
What the markets "love to see is cooperation and doing what's right for the economy," he said.
"If Obama and [Ohio Republican Rep. John] Boehner, if he's Speaker, are butting heads, I can't imagine the markets would be too happy with that."
Republicans are expected to gain upward of 50 to 60 seats on Tuesday, putting them in the majority, although the party leadership is still in question.
Others argue that Democrats should've pressed harder before the election to at least ensure that the middle-class tax cuts were extended and will need to take a more aggressive tack into the lame duck to get something done.
Chuck Marr, director of federal tax policy at the left-leaning Center for Budget and Policy Priorities, said something should've been done by now but that "it's much better to do it now to get rid of that uncertainty."
"It's just damaging the economy to wait," he said.
Marr said it's difficult to know exactly what will happen as it depends on a variety of factors and the willingness of lawmakers to work toward a resolution.
He called a short-term extension of high-income tax cuts "very inefficient" and said that the extra money gathered by letting those rates expire could be used for tax breaks to small businesses to hire people, providing a better economic benefit.
Even if tax cuts are allowed to expire, it's likely that taxpayers would see smaller paychecks for only a short period of time while Congress works out a deal. The IRS could quickly reissue withholding tables so taxpayers recover the earlier higher withholdings, assuming they send out tables with pre-Bush tax rates.
Even Vice President Joe Biden seemed to suggest a willingness to compromise.
Asked in an Oct. 22 interview on Bloomberg TV whether the administration was willing to compromise on the $250,000 threshold, Biden said, "I think it is important we get the middle-class tax cut made permanent. And so I think we are open to speak to the Republicans, if they really mean it, if they are talking about deficit reduction, if they are willing to move."