A successful plan must address the following:
Since there is apparently no appetite for cuts in discretionary government spending, there must be a combination of tax hikes and defense cuts that funds the old pre-crisis budgets of the Bush years. Fortunately, solutions for these deficits are already in place. First, all of the Bush tax cuts must expire (not just for the wealthy) and we should return to Clinton-era tax policies. If the Republicans wanted Americans to keep those tax cuts then they should have spent less when they were in power (and that goes for Pelosi and Reid, who have been approving the budgets since 2006 and didn't object to spending increases in earlier years). Secondly, we must cut costs in Iraq and Afghanistan and scale back our presence in both countries. Fortunately, the combination of restoring Clinton's tax policies and cutting our war expenses in half would have just about balanced Bush's budget back in 2006-2007 (at the peak of the economic cycle).
That is the good news- there are measures in place to handle the pre-crisis Bush deficits and spending.
The bad news is that this leaves us with some gaping holes
1) The TARP, son of TARP, the homeowner and the auto bailouts. Essentially the crisis expenditures
2) The stimulus bill
3) The 8% spending increase in the recent supplemental budget passed by Pelosi/Reid
4) All of Obama's new spending ideas
5) Fixes for social security and medicare
What we need is a grand bargain combining fiscal and monetary policy.
1) Use the expiring tax cuts and declining war expenses to fund Bush's spending increases.
2) The Fed should monetize the debt (i.e. print money rather than issuing bonds) to cover the cost of the TARP and other crisis bailouts and also for any of the stimulus expenditures happening in 2009 and 2010 (this is much less than $787 billion). This would generate at least $2 trillion in monetary stimulus (so a little less than 20% of the economy). This would create a fall in the dollar and a short-term boost for inflation, but it must be a one-off event. Any future returns on TARP money (in the unlikely event our bank preferred shares ever get paid off) should go toward debt repayment.
3) Any new expenditures for 2009 and beyond must be fully funded with tax hikes.
If Obama wants to increase entitlements or add tax cuts beyond those temporary ones in the stimulus he will need to raise new tax revenues to pay for them. His proposed income tax changes raise less revenue on a net basis than the simple expiration of Bush's tax cuts, and the revenues from the expiration of those cuts are already spoken for- they need to be used to reduce the Bush deficit.