Why Obama's Tax Plan Will Pass—Even If He Loses the Election

It would be political suicide for lawmakers to let taxes rise at the end of the year as scheduled.

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Here's one game of chicken that isn't, really: the down-to-the-wire brinksmanship over income tax rates that are scheduled to shoot up at the start of next year.

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The Bush-era tax cuts, which were supposed to be "temporary," are due to expire on Dec. 31. If that happens, the majority of Americans will face a sharp rise in their tax burden, literally overnight. That would wreck the finances of many families living on the edge, and most likely trigger another recession.

So President Barack Obama is now proposing that current tax rates remain at their lower levels for another year for those earning $250,000 or less, while they revert to earlier, higher levels for those earning more. Extending the tax cuts for middle-class families, theoretically, would give the next Congress time to draft a more comprehensive tax-reform plan and address the mushrooming national debt, without torpedoing household finances while the economy remains fragile.

Obama will get his way, because it's almost inconceivable that Congress and the next president would sign off on an abrupt tax hike. "A pragmatic approach will have to win out," says Clint Stretch, who recently retired as managing principal of Deloitte Tax. "The question is what has to go into a package for both political parties to feel they got a win out of it."

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Republicans, of course, favor lower taxes—for everybody. So if Obama wins in November, a deal with Congress may have to include an extension of the lower tax rates for all earners, not just those with incomes below $250,000. If Obama's Republican opponent Mitt Romney wins, it's even more likely that the tax cuts will be extended.

The bigger questions involve what will happen between now and 2014 to rein in the national debt and prevent the government from approaching insolvency. Those issues won't be seriously addressed by the lame-duck Congress that's in session for two months after the November elections. But it will form the agenda for the legislators seated next January. And the fighting will be intense.

One key issue to watch is the federal borrowing limit, which will have to be increased again in early 2013. A short-term deal on extending the Bush tax rates during the lame-duck session could include an agreement to extend the borrowing limit as well, which would forestall the rancor and needless, last-minute drama that surrounded the last increase, in the summer of 2011. But if there is no deal on the debt limit, that's likely to be the first big political battle of 2013—which is more likely if Obama wins.

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If 2013 does start with a comprehensive deal on tax-rate extension and the debt limit, that would open the door to more substantive negotiations about long-term tax and spending policy. Under the best of circumstances, this will be contentions politics. The first order of business will be what to do about $110 billion of spending cuts due to hit in 2013, half in defense and half in other programs. Then will come a bunch of unhappy longer-term decisions, which inevitably will involve cuts to favored programs like Medicare, an increase in the retirement age for Social Security eligibility, a revamp of the corporate and personal income tax code, and eventually, ways to bring in more tax revenue.

The only way all of that is going to happen is if every group with a stake in the outcome—which is to say, most Americans—feels it's getting a fair deal. "None of these things are without pain," says Stretch. "The job of the next Congress is to come up with a plan to inflict pain in small doses." Now if one of the candidates were to admit that, it would be genuine news.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.