What will the lame duck Congress do with the Bush tax cuts?

What will Congress do about the Bush-era tax cuts when it returns for a lame duck session in a couple of weeks? It is increasingly likely that the answer is: Nothing. And that will hardly be an auspicious start for the relationship between President Obama and newly resurgent congressional Republicans.

The returning Congress has only two must-do jobs. It needs to pass a stopgap spending bill to keep the government functioning into next year, and it must address a slew of expiring tax cuts. These include the Bush-era tax cuts of 2001 and 2003, as well as President Obama’s Making Work Pay tax credit—all of which expire on Dec. 31. The lawmakers also must deal with the Alternative Minimum Tax “patch,” and a passel of business tax cuts that actually expired at the end of last year but which almost everyone simply assumed would be extended before 2010 comes to an end.

Since he came to the White House, Obama has insisted he would permanently extend the 2001 and 2003 tax cuts for those making $200,000 or less ($250,000 for couples filing jointly) and let them expire for higher-earners. But when Democrats had the chance to do just that before the election, the Senate blinked. In the face of objections from moderate Democrats, Majority Leader Harry Reid put off the vote.

Now, of course, the political environment has completely changed. Republicans are taking an increasingly hard line against Obama’s plan and demanding that all the Bush-era tax cuts be permanently extended. Obama says he is ready to talk. But knowing they will control the House and a half-dozen more seats in the Senate next year, some GOP lawmakers are already threatening to put off a decision on the tax cuts until after January unless Obama capitulates.

So what will happen? Here are the options:

Adopt Obama's tax hike on high earners. It is dead. Even the President now says he is willing to compromise.

Permanently extend the tax cuts for those making $200,000/$250,000 or less but only temporarily extend them for high-earners. Republicans will never go for it since they’d lose all their leverage when the time comes to extending them again. They know it will be much easier for Congress to continue tax breaks for those high-earners as long as their fate remains tied to the fate of middle-class taxes.

Permanently extend the tax cuts for those making $1 million or less. What about retaining the tax cuts for those making up to $500,000 or even $1 million, while raising taxes for higher-earners? My Tax Policy Center colleagues Jim Nunns and Rachel Johnson have looked at several options that would make up the lost revenue, but they’d result in a new top rate for $1 million+ earners ranging from 41 percent to 50 percent. Not likely to pass muster with Republicans.

Pass the GOP Plan: Even with 47 Republicans, the Senate won't vote to permanently extend all the tax cuts. This is a non-starter, though the GOP may not quite be ready to admit it.

Temporarily extend all the tax cuts--including the AMT patch, the business tax cuts, and Making Work Pay--for a year or two. This increasingly looks like the deal, but are Obama and the resurgent Hill Republicans prepared to sign on? Will angry House Democrats agree, especially as they hear more talk of a government spending freeze?

Kick the can down the road. It is hard to imagine Congress simply leaving town without addressing the tax cuts in some way. Both parties risk a huge backlash if they don’t act. That’s why I’m betting Congress extends the tax cuts for just a few months so they can resume their bickering again next spring. This is execrable tax policy, but it just might serve everyone’s political needs.

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