11/16/2010 11:24 am ET | Updated May 25, 2011

Gridlock Is Not Enough

The fate of former President George W. Bush's expiring 2001 and 2003 tax cuts has been a political dilemma all year. Even with the election resolved, it still is; but now it is an economic dilemma as well.

The uncertainty surrounding those tax cuts was always economically risky. People don't know how much will be withheld from their paychecks just eight weeks from now. In fact, millions of middle- and upper-middle-income people don't know how much they will owe in alternative minimum tax (AMT) for this year when they file their tax returns before April 15. Managing these delays will be a major headache for the IRS and for payroll managers -- and therefore for the taxpayers they serve.

But far worse, the economy is much weaker than many forecasters anticipated. Allowing the tax cuts to expire now could well send the already stumbling recovery into the mud.

So the two parties will duke it out in their lame-duck session of Congress, and it will all be settled, right? No, probably wrong.

Republicans want to extend all of the tax cuts. They cannot do that now, and they cannot do that after the new Congress arrives in January. They can pass such legislation through the new House; the House majority can do anything it wants in the crack of a gavel. But they can't get it through the Senate; they don't have even a majority, let alone 60 votes to stop a filibuster. And even if they could pick off 13 Senate Democrats - an exceedingly tall order - President Obama still has his veto, and the Republicans cannot possibly get a two-thirds vote in both chambers.

Democrats say that they want to extend the tax cuts permanently for everyone from the lower-upper class ($250,000 per year for a family) on down, and to allow the upper-income tax cuts to expire. The Democrats are far stronger now than they will be in January. But they were just as strong before the election. If the Democrats could get that deal, they would have gotten it already. Their ranks are too fractured to win that vote, they have only 59 votes in the Senate anyway, and their probability of winning Republican Senate votes now is less than zero.

Both sides have hostages. If Democrats fail to blink, the estate tax -- after a one-year expiration -- comes back. If Republicans fail to blink, low- and middle-income taxpayers face higher taxes.

But if neither side blinks, all of the tax cuts expire. This is the only outcome that does not require compromise. And expiration of all of the tax cuts would be a jarring blow to the economic recovery.

Meanwhile, the federal government is piling up debt at an alarming rate. In fact, the debt is growing faster than the economy, approaching separation velocity to enter the stratosphere - an ever-increasing cycle of deficits adding to debt adding to debt service adding to deficits. Just about everyone agrees that we must get the economy to liftoff first, but that slowing the deficit cannot be far behind. Both political parties pledged budget control in the elections. So surely budget action is high on the agenda, right?

Again, no. The gridlock on the expiring tax cuts is a branch office of the likely gridlock on the budget. Everyone is for deficit reduction. No one will say how. Both sides have made "pledges." The only way to get the specifics on parchment is through a bipartisan deal, with each side providing cover for the other. But there are no signs of cooperation, or even communication.

In the 1990s, some say, gridlock balanced the budget. The economy was strong, the budget was improving, and the deficit fell simply because no one made it worse. Although that reading is questionable, it makes an important point: Today, gridlock clearly is not enough. The budget is heading the wrong way. It will explode if no one fixes it. And the economy is weak.

In fact, we believe that the two years of the next Congress is too long not to act. The markets do not need a solution right now, but they need a commitment to find one, and soon.

So we are deadlocked on the expiring tax cuts, and deadlocked on the budget. Inaction leads to enormous economic risk, or worse - and each party thinks that it wins politically from inaction, and has pledged publicly not to compromise. How to square the circle?

Here is one way:

Both sides say the nation needs deficit reduction, and that they want the nation to succeed. OK, prove it. Commit to a two-year bipartisan process to find a solution.

Democrats want the upper-income tax cuts to expire. Republicans want them made permanent. We cannot let all the tax cuts expire. Let's split the baby: Extend all of the tax cuts, but for two years. That avoids the shock to the economic recovery.

How do we know that the deficit reduction will happen? Tie it to the tax cuts, but with a trap door under both sides' hostages. If the bipartisan negotiators fail to reach agreement, then the tax cuts expire, and spending is cut across the board to achieve equal savings. If this trap door were sprung, the deficit would be reduced by enough to make the budget sustainable. This trap door is absolutely workable, absolutely credible, and absolutely awful. It is precisely what is needed to motivate both parties to negotiate in good faith - to reform the tax code and streamline government programs while cutting the deficit to size.

Is it politically realistic for the two parties in Congress to agree to such a deal? Most probably not. But by that standard, the only politically realistic outcome is an eventual budget and economic meltdown. Follow a straight line from the recent pattern of Washington policymaking behavior, and these problems don't get solved. Either we change the way Washington is working, or the whole nation suffers. (That was the premise of the election, right?)

But even if it is "unrealistic," this bargain is perfectly consistent with both parties' claims. They both say they want at least some of the tax cuts. They both say they want to fix the budget.

So are you willing to put your tax cuts where your mouth is?

Joe Minarik is the Senior Vice President and Director of Research, Committee for Economic Development (CED). From 1993 to 2001 Dr. Minarik served as the OMB associate director for economic policy.