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A Tax Refund That Could Help Congress Over Cliff

Illustration by Jaci Kessler Close

Illustration by Jaci Kessler

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Illustration by Jaci Kessler

As the fiscal cliff, the federal spending cuts and tax increases scheduled to take effect in January, looms ever closer, an informal consensus along the Acela corridor is coalescing around a placeholder deal with details to be filled in over, say, nine months. The deal would come with some backstop enforcement mechanism in case those details never materialize. (Sound familiar?)

Such a prospect raises a vital question: During the nine or so months, what would happen to the tax cuts?

Let’s focus on the scenario in which President Barack Obama is re-elected. The White House has insisted that it will not agree to extend the expiring tax cuts for those with incomes of more than $250,000. Yet House Republicans insist on universality, ruling out an extension that excludes those income classes.

If the White House were to agree, at Republicans’ insistence, to temporarily extend all the tax cuts for the placeholder period, how many people would believe it was serious about ending the high-income tax cuts thereafter? This impasse is one reason I have been a bit skeptical that even a placeholder deal will come together before Dec. 31.

(Such a deal is more likely if the economy weakens, because then the administration would be more eager to avoid the uncertainty associated with delaying a deal into January. Or, if the House Republicans suffer a significant loss in the elections next week, it might cause them to reconsider their tax stance. Neither of these possibilities seems likely at this point, however. And if Obama wins the Electoral College vote but Mitt Romney, his Republican challenger, wins the popular vote -- so both sides feel they have a mandate -- or if legal disputes in some states make the election outcome uncertain for some period, it will only be more difficult to get a deal done before the end of the year.)

Tax-Reform Refund

So here’s an idea for how to get out of this box, assuming Obama wins: Agree soon after the election to allow all the tax cuts to expire and replace them, while the negotiations are ongoing, with a temporary “tax-reform refund” of $1,600 per person. Anyone who works or receives Social Security benefits would qualify for the refund. The total cost would be about $350 billion on an annualized basis, enough to protect the economy from the bulk of the impact of a sudden end to the tax cuts. The refund would remain in place until a deal was reached, or the unemployment rate fell below 7 percent, whichever occurred first.

More specifically, the tax-reform refund would be delivered through reduced withholding for the roughly 160 million workers who pay payroll taxes and in the form of a supplemental benefit payment for the 56 million people who receive Social Security. The reduction in employer withholding would boost take-home pay for about 75 percent of families, and the increase in Social Security benefits would do the same for most of the rest. (Those who fall through the cracks could apply to receive their tax- reform refund through their annual tax return, which could also be used to address problems such as potential double-dipping by Social Security beneficiaries who continue to work.)

What would be the benefits of the tax-reform refund? First, it wouldn’t prejudge what ultimately happens to the tax cuts during the negotiating process, since all of them would have expired. Negotiators could therefore start from a clean slate.

Compared with extending only the tax cuts below $250,000 during the negotiating period, this option would appeal more to Republicans. And the White House should prefer it to extending all the tax cuts.

Universal Benefit

Second, the refund would be universal, meeting another criterion put forward by House Republicans, who are more likely than other policy makers to be skeptical about it. (If absolutely necessary to win Republican votes, the temporary refund could be paired with a hold on current tax rates for capital gains, dividends and estates during the negotiating period -- though it would be better to avoid doing that.)

Third, a temporary refund would be far more progressive than the expiring tax cuts, which should help the still-sluggish recovery and please supporters of the administration. Married couples would receive $3,200 regardless of income, as long as they worked or received Social Security benefits.

Fourth, the tax-reform refund could be voted on in mid- December -- assuming the parties can’t reach an agreement on the tax cuts by that point -- facilitating a placeholder deal before the end of the year and avoiding the turmoil that would occur if no deal were reached. To accomplish that, the Obama White House would have to hold firm to its objection to temporarily extending all the tax cuts. That way, it could present the Republicans with a simple choice: Since we can’t agree, all the tax cuts will expire, and the only question is whether we put in place a temporary refund.

Finally, the refund would explicitly be temporary, putting additional pressure on the negotiators to reach an agreement over tax reform -- which is always easier said than done. If a deal were not reached, the refund would remain in place until the economy recovered sufficiently, but then would be gradually phased out as the unemployment rate fell below 7 percent.

The tax-reform refund wouldn’t be perfect, and we might well end up being disappointed with whatever deal followed the refund’s enactment. But in the absence of other ideas about how to resolve the impasse before Dec. 31, it may be our best hope.

(Peter Orszag is vice chairman of corporate and investment banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)

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Today’s highlights: the editors on the tax initiatives on California’s ballot and on why you shouldn’t read too much into the jobs report; Clive Crook on why Obama is the least bad choice for the U.S.; Part three of A. Gary Shilling’s series on who loses when the Fed keeps interest rates low; Part one of Virginia Postrel’s series on missteps by breast-cancer charities; Tim Judah on the rise of the far-right party Svoboda in Ukraine.

To contact the writer of this article: Peter Orszag at orszagbloomberg@gmail.com

To contact the editor responsible for this article: Mary Duenwald at mduenwald@bloomberg.net

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