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Tax Pledges Confound Obama Debt Deal With Republicans

Tax Tradeoffs Central As Obama Meets With Congressional Leaders
President Barack Obama meets with congressional leaders, including House Speaker John Boehner, left, at the White House July 10, 2011. Photographer: Joshua Roberts/Bloomberg

President Barack Obama’s insistence on higher taxes for top earners and Republicans’ refusal to raise rates leaves negotiators with arithmetically complex and politically fraught choices.

Tax questions will be central today as Obama holds his first face-to-face conversation with House Speaker John Boehner and other congressional leaders since the Nov. 6 election. While the two sides discuss options on how to increase revenue, among them is a down payment on replacing automatic spending cuts should talks on a bigger plan fail, according to congressional aides.

Another alternative would be to raise Obama’s $250,000 income threshold for a tax increase to $500,000 or $1 million and increase the current 35 percent top rate to 37 percent as opposed to the 39.6 percent level under President Bill Clinton, Peter Orszag, Obama’s former director of the Office of Management and Budget, said today on Bloomberg Television.

“Will John Boehner really blow up a deal for a 1 percent point increase above $1 million?” Orszag said. “The administration has made it clear there has to be at least some increase in marginal tax rates.”

Also at the White House meeting Obama is hosting on the so-called fiscal cliff will be House Minority Leader Nancy Pelosi, a California Democrat, Senate Majority Leader Harry Reid, a Nevada Democrat, and Senate Minority Leader Mitch McConnell, a Kentucky Republican.

$607 Billion

The $607 billion fiscal cliff is the combination of tax increases and spending cuts that will take effect in January if Congress doesn’t act. Lawmakers of both parties want to avoid a short-term shock to the economy while making progress on long-term deficit reduction.

The president supports higher taxes for top earners mixed with some spending cuts. Republicans want to extend expiring tax cuts for all income levels and are demanding an overhaul in 2013 of entitlement programs and the tax code.

While insisting on higher taxes, Obama has shown some openness in recent days. He and Treasury Secretary Timothy F. Geithner said rates must increase without specifying that the top rate must return to the 39.6 percent level in effect when President Bill Clinton left office.

Fallback Plans

Several congressional aides have suggested that in the event talks fail, both parties in Congress are discussing fallback plans for $60 billion to $100 billion in deficit reduction to replace automatic spending cuts set to take effect in January.

As they try to find a solution both sides can accept, some moves that ease the math complicate the politics. Republicans oppose higher rates while the limits on tax breaks they prefer generate opposition from interest groups that rely on them, including nonprofit organizations, the home-building industry and residents of high-tax states.

“To get serious revenue, you have to go after the stuff that’s big,” said Alan Viard, resident scholar at the American Enterprise Institute, which favors limited government. “By definition, the stuff that’s really big are the things that people are really using.”

Following a 2011 agreement to lift the nation’s borrowing limit that contained $1.2 trillion in Republican-driven spending cuts and an election where Democrats picked up seats in the House and Senate while campaigning on an upper-income tax increase, the party believes it’s well positioned to secure a debt-reduction package weighted mostly toward revenue.

‘The Moment’

“This is the moment where the revenue piece comes directly into play,” said Maryland Representative Chris Van Hollen, the top Democrat on the House Budget Committee.

Representative Steve King, an Iowa Republican, said Boehner, an Ohio Republican, could probably get a revenue package through the House that curbs deductions and credits for the highest earners and slightly raises rates above the current 35 percent level, as long as it falls short of the 39.6 percent that Obama wants.

“It may not have to be the 39-and-a-half percent number, it could be something less than that; if he can squeeze a little more money out of it by closing loopholes I think he’ll make that deal,” King said of the president.

While it “will be tough” to get through the House, “it doesn’t mean it won’t get through the House,” King said. “There might be enough pressure could come on John Boehner that more votes come from Democrats than Republicans.”

Treasury Notes

Treasury 10-year note yields traded at almost two-month lows. The yield was little changed at 1.59 percent at 9:21 a.m. New York time, according to Bloomberg Bond Trader prices. The Standard & Poor’s 500 Index fell 0.2 percent to 1,353.33 at 9:52 a.m. in New York, the lowest level since July 25.

Today’s meeting features the same actors who failed to reach agreement in 2011. It won’t be the start of back-to-back meetings. Obama leaves for Asia tomorrow and Congress is departing Washington until Nov. 26 for a Thanksgiving recess.

“I wouldn’t expect a lot of movement today,” said Orszag. “That’ll come after Thanksgiving.”

Boehner and Obama, who tried to reach a deficit-reduction deal in 2011, resume their negotiations with the election behind them and with markets reacting to their comments and tone. Since the election, they have each expressed a willingness to work together.

Potential Compromise

They have left an opening for a potential compromise on deficit reduction. Still, with 46 days until the Dec. 31 deadline, there are dozens of moving parts -- on taxes, spending and congressional process -- and plenty of obstacles.

A significant issue is a lack of agreement on how much deficit reduction the negotiators want to achieve and how much of that should come from taxes.

Obama wants $1.6 trillion in higher taxes for top earners over the next decade, achieved through a combination of limits on breaks and higher tax rates on ordinary income, capital gains, dividends and estates.

Trying to replace the entire $1.6 trillion by curbing tax breaks would be very difficult, Viard said, echoing the problems that Republican presidential candidate Mitt Romney had in making his tax proposals add up.

McConnell described the $1.6 trillion figure as a “joke” on the Senate floor yesterday.

‘Open Mind’

“If the president’s got an open mind, maybe he’ll see that Republicans are the ones who’ve expressed a willingness to step out of our comfort zone if it actually leads to solution,” he said.

A smaller target would make it easier to design a limit on tax breaks that could achieve the goal, be politically acceptable and stick to Obama’s pledge of avoiding higher taxes for Americans with incomes of less than $200,000 a year for individuals or $250,000 for married couples.

For example, capping itemized deductions at $50,000 would raise $749 billion over the next decade, according to the nonpartisan Tax Policy Center. That would drop to $490 billion if charitable contributions don’t count toward the cap.

That cap, unlike Obama’s budget, would apply to more than the top 2 percent of taxpayers. Considering the version that doesn’t touch charitable contributions, 72.5 percent of the higher taxes would be paid by people with incomes exceeding $1 million a year. About 10 percent, though, would be paid by people with incomes below $200,000.

$1.6 Trillion

Obama’s $1.6 trillion goal already includes almost $750 billion from limits on tax breaks. Most of that, or $584 billion, comes from requiring people in the highest tax brackets to take their deductions and exclusions as if they were in the 28 percent bracket.

Limits on tax breaks would spur lobbying from affected groups and objections from lawmakers whose constituents would be disproportionately affected.

“It’s not like all itemized deductions are necessarily created equal,” Viard said.

Charitable contributions are the most discretionary for taxpayers. Many taxpayers would reach a cap on deductions with state and local taxes and mortgage interest, effectively eliminating any tax incentive for charitable giving, said Steve Taylor, senior vice president for public policy at United Way Worldwide in Alexandria, Virginia.

“The proposals that are being talked about now could really have a potentially dramatic, if not devastating impact on the charitable sector,” he said.

Hidden Increase

The more stringent the tax-break limit, the more it operates like a hidden marginal rate increase, said Daniel Shaviro, a tax law professor at New York University.

Unless taxes on investment income are raised, he said, limits on tax breaks have the biggest effect on people with incomes closer to $250,000. The benefits of tax breaks for health insurance and home mortgage interest are smaller in comparison with the highest earners’ income.

“The guys at the top, they’re going to come out ahead, unless they were being very generous to charity,” Shaviro said.

Even with the tricky math and opposing positions, there are some signs that the sides are moving closer together.

Republicans, who have long objected to higher taxes, have started moving rhetorically toward accepting the idea of pairing spending cuts with tax increases.

Not Clear

They haven’t been clear about what they would accept. Republicans are also insisting on major changes to entitlement programs. They haven’t put tax increases before their own members, many of whom were re-elected Nov. 6 on a promise not to raise taxes.

It’s unclear how far Boehner can go on new revenue. He and Obama tentatively agreed to $800 billion in 2011. They didn’t finalize the deal and Boehner didn’t bring it to a vote.

House Ways and Means Chairman Dave Camp of Michigan said in a speech prepared for the Tax Foundation last night that his committee will pass a tax overhaul plan in 2013 “no matter what.”

At the same time, Obama and other Democrats say the math wouldn’t add up in an approach that relied only on reducing tax breaks, and some congressional Democrats say they want the top rates to revert to the Clinton-era levels.

Boehner told reporters Nov. 14, “There are ways to put revenue on the table without increasing tax rates,” though he wouldn’t discuss specifics.

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