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Deficit talks will test the GOP focus on tax rates

9:37 PM, Nov 12, 2012   |    comments
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The distinction might mean little to Americans who end up with larger tax bills even if their tax rates don't change. This politically tricky trade-off is about to take center stage in negotiations over how to reduce the federal deficit and avoid going over the "fiscal cliff" in just seven weeks.

The White House says wealthy Americans must pay a higher tax rate to help produce more revenue to lower the deficit. Congressional Republicans refuse, and many want tax rates to fall instead. But they say they are open to other means of higher tax collections, which might include limits to itemized deductions.

About one-third of U.S. households itemize deductions rather than take the standard deduction. Some of these itemized deductions, such as the one for mortgage interest payments, are popular and deeply ingrained in the American culture.

Many Republican lawmakers are tip-toeing around the issue. But Sen. Saxby Chambliss, R-Ga., warns of possibly huge changes affecting millions of people.

Chambliss told the Atlanta Journal Constitution that federal revenues can be increased significantly without raising tax rates, by limiting deductions. But he noted the popularity of the most important deductions, which are granted for mortgage interest, charity gifts and health care costs.

"It can be done, but it's going to require the elimination of almost all- if not all - tax deductions and tax credits," Chambliss said. "That's going to be difficult."

Congress has raised and lowered income tax rates many times over the past few decades. Currently, a married couple pays 15 percent on taxable income between $17,400 and $70,700. Four higher tax rates apply to incomes beyond that.

The rate a couple pays is only one factor in their overall tax bill. Deductions or credits for child care, charitable giving, medical costs and other expenses can make big differences.

President George W. Bush achieved major cuts in income tax rates in 2001 and 2003. Since then, GOP lawmakers have taken increasingly tough stands against letting those cuts expire - as they now are scheduled to do at the end of the year.

President Barack Obama campaigned this year on a pledge to end the Bush-era tax breaks for families making more than $250,000 a year. The White House said Friday he will veto any deficit-reduction package that fails to do so.

Republican leaders say they are just as adamant that no one's tax rate rises.

Unless one side yields, Congress and the White House seem unlikely to agree on a new deficit-shrinking plan of tax hikes and spending cuts. Without an agreement, a huge package of spending cuts and tax increases, which both parties dislike, will take effect in the new year.

The debate highlights Republicans' ideological emphasis on income tax rates, a topic they discuss far more than other tax matters, such as the Social Security payroll levy. The question of tax rates has achieved "holy grail" status, said veteran GOP strategist Terry Holt. One reason, he said, is that raising or lowering deductions is "considered more overtly social engineering, the government rewarding certain behaviors."

Chris Van Hollen, the House Democrats' top Budget Committee member, said Republicans' "obsession with small changes in tax rates goes back to this pixie-dust theory that if you cut tax rates for wealthy people, it pays for itself" through job creation. "That theory went bust," he said.

Republican presidential nominee Mitt Romney briefly suggested limiting itemized deductions to $17,000 a year. The plan would have raised $1.7 trillion over the next decade, according to the non-partisan Tax Policy Center. But it would have increased taxes on millions of people, including about 27 percent of households making $50,000 to $75,000 a year.

Now, GOP congressional leaders are suggesting that limits to itemized deductions might be acceptable. But they have offered few details.

The tax code includes "all kinds of deductions, some of which make sense, others don't," House Speaker John Boehner, R-Ohio, said last week. "By lowering rates and cleaning up the tax code, we know that we're going to get more economic growth."

Van Hollen said Democrats will demand specifics.

U.S. taxpayers enjoy about $1.2 trillion in tax breaks each year, including credits, deductions and exemptions that lower their federal tax bills. More than a quarter of those tax breaks go to households making above $1 million. About a third of them go to households making more than $500,000, according to the Tax Policy Center.

Lawmakers could raise a significant amount of money by reducing or eliminating some tax breaks for the wealthy - without raising tax rates. But tax experts warn that it wouldn't be easy because all of those tax breaks are important to powerful interest groups.

William Gale, a former economic adviser to President George H.W. Bush, notes that while tax rates have gone up and down over the years, federal tax breaks for owning a home, donating to charity, raising children and paying local taxes have endured.

Why? If lawmakers try to reduce tax breaks for owning a home, the housing industry complains. If they try to reduce the deduction for making a charitable donation, charities, universities and other nonprofit groups complain.

"Historically, it has never been easy, which is why those tax breaks are still in the code," said Gale, a senior fellow at the Brookings Institution.

Obama has repeatedly proposed limiting itemized tax deductions for high-income families. But Congress has largely ignored his plan, even when Democrats controlled the House and the Senate.

Currently, the top income tax rate is 35 percent on taxable income above $388,350. If a person making more than that gives $1,000 to charity, he can reduce his taxes by $350. Under Obama's plan, the same taxpayer would save only $280.

In general, economists say it is better to raise additional revenue by doing away with tax breaks rather than raising tax rates, said Roberton Williams, a senior fellow at the Tax Policy Center. Raising tax rates can be a disincentive to working harder, because the person gets to keep less of each extra dollar he earns.

Eliminating tax breaks can have other effects. Reduce the mortgage interest deduction and people will buy smaller homes, Williams said. Reduce the charitable deduction and they may donate less money.

Bob Bixby of the Concord Coalition, which advocates balanced federal budgets, said lawmakers must spell out exactly which deductions they want to trim if any deficit-reduction compromise is to occur.

"It's important for people to start talking about those by name," Bixby said, "and not just about `closing loopholes.'"

(Copyright 2012 by The Associated Press. All Rights Reserved.)

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