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Obama's New Twist on the Bush Tax Cuts

President Obama is talking about taxes again. And he’s saying the right things. Mostly.

Speaking from the White House on Monday, Obama unveiled a new proposal for handling the Bush tax cuts, which are set to expire at year’s end. Obama wants to extend, by one year, the cuts on incomes below $250,000, while allowing the cuts on incomes above that threshold to lapse.

From a policy perspective, this approach makes a lot of sense. The Bush tax cuts have significantly reduced government revenue, making it more difficult to support programs like Medicare and Social Security on which the middle class, as well as the poor, depend. Allowing these tax cuts to expire is pretty much a prerequisite for any long-term strategy designed to make the federal government more financially sound.

Allowing the tax cuts on upper incomes to expire would also strike a much-needed blow against economic inequality. As my colleague Tim Noah has written (in his book, The Great Divergence, among other places) and as Paul Krugman reminds us today, tax rates on the very wealthy are at historic lows.

But the economy remains weak. And while allowing taxes on the rich to rise might not have much effect on economic performance, because they tend to be less sensitive to changes in rates, allowing taxes on the middle class to rise could further weaken the recovery, because middle class people tend to reduce what they spend in response to even modest reductions in their incomes. That’s a good reason to let their tax cuts stay in place, in some shape or form, at least temporarily.

The problem is the “temporarily” part.

It’s never easy letting expiring tax cuts lapse. Obama and the Democrats may say they want to extend the middle class tax cuts for only a year. That doesn't mean that want them to expire a year from now, or that they could even if they tried. And if the middle class tax cuts stay on the books indefinitely, preserving key government programs and stabilizing federal finances over the long run will become more difficult.

What to do about that? I remain intrigued by a proposal I first heard from former Obama budget director Peter Orszag, although I’m not 100 percent sure he was the one who put it on the agenda. The idea would be to limit the tax cuts by economic conditions, rather than time: In other words, Congress could set the middle class tax cuts to expire whenever the economy hit a certain threshold of strength—unemployment below 7 percent or something like that—rather than by a certain date. Such an approach would turn the Bush tax cuts for the middle class into an “automatic stabilizer”: It would provide a boost for the economy only for as long as the boost was necessary.

I've never seen anybody sketch out the mechanics of how such a cutoff would work in practice. I can also imagine potential drawbacks to this approach. But lawmakers are unlikely to resolve this issue before the election anyway, which means there's plenty of time to explore it further.

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