Barack Obama’s biggest test on tax policy will come even before his second term starts Jan. 20.
The president wants to use an end-of-year showdown with Congress to force higher taxes on top earners and fulfill a promise from his 2008 and 2012 campaigns. To succeed, he will have to risk raising taxes for everyone or persuade Republicans to drop their demand to extend expiring tax cuts for all income levels.
“People making all this money have to contribute a little bit more,” Senate Majority Leader Harry Reid, a Nevada Democrat, told reporters today.
Obama wants to take advantage of the leverage gained from his victory and his veto power to pursue a “grand bargain” that would avert the so-called fiscal cliff and employ a combination of tax increases and spending cuts to reduce future budget deficits.
“We’re going to be in a position where I believe in the first six months we are going to solve that big piece of business,” Obama told the Des Moines Register on Oct. 23. “It will probably be messy. It won’t be pleasant. But I am absolutely confident that we can get what is the equivalent of the grand bargain that essentially I’ve been offering to the Republicans for a very long time.”
The negotiations will occur as the U.S. approaches the fiscal cliff, $607 billion in spending cuts and tax increases that will start in January unless Congress acts. Inaction would likely lead to a recession, according to the Congressional Budget Office.
The challenge for Obama is that his negotiating partners oppose his plans for tax increases and haven’t said they will relent.
“I think the election itself was a pretty narrow win,” Representative Peter Roskam, an Illinois Republican, said in an interview today. “And if it was a mandate, you would have seen Nancy Pelosi coming in again as speaker of the House.”
The fact that Obama campaigned and won re-election on tax increases on high-income taxpayers will force Republicans to give him what he wants, said Kenneth Kies, a Republican tax lobbyist.
“As much as I think it would be a terrible thing to do, I don’t see how they cannot agree to it,” Kies said.
Roskam, who is on the tax-writing Ways and Means Committee, said in the interview that Obama would eventually sign a one-year extension of all the expiring tax cuts as a bridge to an overhaul of the tax code -- which is the House Republican position.
“He has shown a great deal of political dexterity when he needs to,” said Roskam, who served with Obama in the Illinois state Senate. “Remember, we heard all the same language in 2010 about the extension of the rates then.”
In a speech yesterday as the Republicans neared clinching House control, Speaker John Boehner said the election wasn’t a “mandate for raising tax rates.”
The Ohio Republican’s emphasis on “tax rates,” as opposed to “taxes,” indicates that the party may pursue policies that would curtail tax breaks to pay for keeping rates where they are now. Republican congressional aides told Bloomberg News Oct. 19 they were designing options that would achieve those goals if the politics move in that direction.
Roskam said a tax overhaul that spurs revenue from economic growth is the best way to increase government collections. Asked whether the Republicans’ red line was avoiding higher tax rates or higher taxes, he said, “That’s going to be an interesting question.”
The kind of framework agreement on deficit reduction that Obama says he wants eluded the president during talks with Boehner in 2011. Two separate rounds of talks among high-ranking lawmakers also failed to resolve the divide between Democrats and Republicans on fiscal policy.
The lame-duck Congress that returns to Washington next week is the same group of lawmakers who resisted Obama’s tax proposals, and the alignment won’t change much in January.
Republicans who want to extend all the tax cuts will keep their majority in the House. Democrats will control the Senate again, though Republicans can use procedural maneuvers to block most action.
Obama wants to boost top income-tax rates back to the levels they reached when President Bill Clinton left office in 2001 -- at 36 percent and 39.6 percent. He also wants higher taxes on capital gains and dividends than exist now and a smaller estate-tax exemption and higher rate.
The tax cuts enacted in 2001 and 2003 under President George W. Bush and extended by Obama in 2010 expire at the end of this year.
Obama maintains that letting tax cuts for top earners expire is essential to what he calls a balanced approach to deficit reduction that includes spending cuts and tax increases. Republicans counter that higher taxes for anyone would hurt the economy.
Obama’s mandate is “to lead,” said John Engler, president of the Business Roundtable, a Washington-based association of chief executives.
“There’s going to be reluctance in the Congress to put a lot of revenue on the table,” said Engler, a former Republican governor of Michigan.
The deadlock on that issue will make it hard for Congress and Obama to reach an agreement on deficit reduction without an economic crisis forcing action, Kies said.
“I think we muddle along and certainly, getting tax reform done would be very difficult,” he said.
Douglas Holtz-Eakin, a former director of the Congressional Budget Office, predicted that as in 2010, Obama will initially to extend all the tax cuts to prevent economic harm and later will seek higher taxes on top earners.
“He’s going to be able to come back in 2013 and say, ‘Hey, I won twice, time for these rates to go up,’” said Holtz-Eakin, who was an adviser to Arizona Senator John McCain, Obama’s 2008 opponent.
Other pieces of Obama’s tax policy aren’t directly tied to the fiscal cliff.
The president wants to cap tax breaks for high earners, including the deduction for charitable contributions and the exclusion of municipal bond interest.
He has offered a series of miscellaneous policy changes, including taxing the carried interest of private equity managers as ordinary income, instead of at the lower capital gains rate, and removing about $4 billion a year in tax breaks from the oil and gas industry.
Republicans have resisted those proposals.
Obama and the Republicans agree more on the general direction of corporate tax policy. Both want to lower the rate and remove or curtail tax breaks.
They disagree over what should happen to international taxation. Obama wants tighter rules that would limit companies’ ability to defer U.S. taxes on profits they earn outside the country.
Republicans want a so-called territorial tax system that would impose a lighter tax burden on U.S. companies’ foreign income.