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Economic Scene

In Tax Cuts, the Options Run Short

WASHINGTON

Democrats have left themselves in a tough spot on the Bush tax cuts. After delaying the issue until after the election and then being trounced in that election, they find themselves with little leverage.

If they cannot come up with a plan that can win 60 votes in the Senate, which means at least two Republican votes, Republicans can filibuster any bill. All of the tax cuts would then expire on Dec. 31. When the new Republican House majority arrives in January, it will be able to make its first order of business a retroactive tax cut — forcing President Obama and Senate Democrats to choose between a purely Republican plan and an across-the-board tax increase.

So the big question is whether Democratic leaders can come up with any compromise that centrist Democrats and a couple of Republican senators — Scott Brown, who represents liberal Massachusetts? George Voinovich of Ohio, who is retiring? — are willing to accept.

Much of the recent commentary about the tax cuts has skipped over this political reality. It’s instead focused on how tough the Democrats should be and whether they should insist on the expiration of all the Bush tax cuts on income above $250,000 a year. But that’s no longer one of their options. Unless they believe they will benefit more than Republicans from a standoff in which taxes go up, which is hard to believe with a Democrat in the White House, their only choice now is among various versions of retreat.

A small group of Obama administration officials and lawmakers from each party will be negotiating over the next few days, and two possibilities are getting the most attention.

The first is a millionaire’s tax, in which the Bush tax cuts would be extended only on income below $1 million. This would raise only half as much as Mr. Obama’s proposal — allowing the cuts to expire on all income above $250,000 — but it would still eliminate roughly 8 percent of the medium-term budget deficit. A millionaire’s tax would also mean that the tax code would again begin to distinguish between the merely affluent and the truly wealthy, as was the case decades ago.

The second, more likely option is to extend all the tax cuts — and to package them with other tax cuts and spending likely to do more to help the economy than the Bush tax cuts. (Remember, after President George W. Bush signed the cuts in 2001, the economy lost jobs for the next two years, and economic growth during his presidency was mediocre.) These other measures could include a tax cut for businesses that added workers, an across-the-board payroll tax cut and an extension of unemployment benefits.

Combining the two ideas — using the revenue from the millionaire’s tax to pay for job creation programs — may also be possible. Senator Mark Warner, a moderate Virginia Democrat, has been pushing a somewhat similar idea.

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Senator Mark Warner has proposed letting some tax cuts expire and using the revenue for incentives to create jobs.Credit...Melissa Golden/Bloomberg News

The safer strategy is focusing on job creation, without involving the millionaire’s tax. Republicans would then be forced to accept additional tax cuts, some of which were originally Republican ideas, or to stand in the way of extending the Bush cuts. Democrats, for their part, could avoid repeating their mistake of early this year, when they assumed a recovery was under way and failed to do enough to help the economy.

Today, the economy looks strikingly similar to the way it did at the start of the year, with the latest numbers again pointing to a recovery. Retail sales over Thanksgiving weekend were strong. The last jobs report showed more hiring than expected. Yet the outlook remains highly uncertain, partly because of the debt troubles in Europe.

The great historical lesson of financial crises is they tend to have bigger, longer-lasting effects than policy makers think. Congress and the White House now have a chance to take out an insurance policy against the risk that the recovery will fade in coming months, just as it did over the summer. Because the Bush tax cuts will expire unless new legislation is enacted, they offer a chance to get that insurance policy through Congress.

The political argument for taking a risk and trying to pass the millionaire’s tax is that it will allow the Democrats to cast themselves as friends of the middle class. The economic argument is that such a tax would probably do more long-term good than any of the other remaining options.

The country, as you’ve no doubt heard, is facing a huge budget deficit. To reduce the deficit to a level economists consider sustainable, Washington needs to find about $400 billion in annual tax revenue and spending cuts by 2015. A millionaire’s tax would be a good start, producing about $30 billion a year. By comparison, Mr. Obama’s plan to freeze federal workers’ pay would save about $5 billion a year.

A millionaire’s tax would also fall on an income group that, by almost any definition, can best handle a tax increase. Since 1980, pretax income for households making at least $1 million has more than tripled, after adjusting for inflation. Pretax income for households in the dead middle of the income distribution, making roughly $50,000, has risen just 13 percent.

At the same time, the wealthy have received a much bigger tax cut over the last three decades than any other group. The total federal tax rate on households making more than $1 million — including the income tax, the payroll tax and others — was above 50 percent in 1980. In recent years, it has been about 33 percent.

Finally, a millionaire’s tax would make a distinction between the 400,000th dollar of income and the 40 millionth dollar. Today, the government taxes those dollars at the same rate, which is hard to justify in a country with a progressive tax system and high inequality. Until the 1970s, the highest tax bracket began at more than $1 million a year in today’s dollars.

So which route should Democrats take? It depends on whether they think they have any chance of persuading a couple of Republicans to vote for a millionaire’s tax. If the Democrats fail and don’t leave themselves enough time to pass a bill with job creation measures, they will be facing total capitulation — an extension of the high-end Bush tax cuts with nothing in return.

And what should the Republicans do? Perhaps, when faced with the final choice, a few of them will be willing to vote for either reducing the deficit or helping the economy.

E-mail: leonhardt@nytimes.com

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: In Tax Cuts, The Options Run Short. Order Reprints | Today’s Paper | Subscribe

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