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Pieces in place to craft grand bargain on taxes

Here’s an anecdote to guide everyone’s thinking about the economy over the next few months.

In January 2009, a newly inaugurated President Barack Obama invited Republican leaders in for a chat. When he resisted their call for tax cuts, the president clumsily – to his audience, arrogantly – reminded them that he had won and their guy had lost.

The Oval Office session turned icy cold, setting the tone for four years.

Obama must do the opposite this time by figuring out how to turn the losers’ survival instincts to his advantage.

House Speaker John Boehner, the day after the 2012 election, pointed the way.

He said Republicans could accept new tax revenue in the form of a tax-code overhaul to lower the deficit so long as it is accompanied by changes to entitlement programs.

In other words, give us the political cover we need to raise taxes.

That’s the kind of bargain we’ve been urging all along – tax reform in exchange for controlling spending on entitlements. And there isn’t a whole lot of time to waste: A recession will almost certainly result if the two sides can’t agree to replace $600 billion of automatic spending cuts and expiring tax breaks with a more reasonable, longer-term, deficit-cutting plan.

The mixed election results should guide the negotiators. Obama won big in the Electoral College, but Republicans retained control of the House. Voters in Arkansas, in California and in the city of San Antonio approved narrowly focused ballot measures to raise taxes for education, highways and other public works, yet similar initiatives in Arizona, Missouri and South Dakota failed.

While it would be hard to say that Americans fell in love with the idea of government, they did seem to acknowledge that there were some things only government could do. The success of the auto bailout, for example, probably put Obama over the top in Ohio.

Add it all up, and the picture we get is this: Americans would accept an increase in taxes if some of the money is invested in areas essential to jobs and economic growth.

But it would be a mistake for Obama to assume he can simply let the Bush tax cuts expire in January – then ride to the rescue of the middle class by proposing lower taxes on incomes of less than $250,000. That would be the equivalent of saying “I won” all over again.

Democrats urging such a strategy mistakenly believe House Republicans would take the blame for the economic blow and would drop their insistence on lower taxes. Based on last year’s debt-ceiling fiasco, we suspect voters would hold both parties responsible, and that the market reaction would be fierce.

The smarter move is to give House Republicans cover for tax increases by adopting broad-based tax reforms, including a gradual reduction in the value of tax expenditures like the mortgage-interest deduction. Boehner was right when he said the parties aren’t that far apart: Romney and Obama have offered similar proposals that would limit the value of deductions as income increases. Any deal must also slow the growth of entitlements.

There are many ways to do this. The plan by the president’s Simpson-Bowles deficit commission is a good starting point. Another is the $2.3 trillion mix of spending cuts and tax increases that Obama and Boehner drew up before their talks collapsed last summer. The savings should add up to $3 trillion over 10 years ($4 trillion when already-enacted savings are included), with roughly a 3-to-1 ratio of spending cuts to tax increases.

Congress needn’t come up with the entire package in a post-election session. It will take months to finalize. But before leaving for the holidays, lawmakers owe voters the broad outlines of an agreement, a $100 billion down payment, and a timeline for completion of the hard work. Then they can safely walk us back from the vertiginous tax increases and spending cuts known as the fiscal cliff.

The plummeting stock market the day after the election is a sneak peek at what awaits the country if Obama and Republicans can’t make amends soon.

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