Budget Negotiators Face Complex Choices

Obama to meet with congressional leaders today before Congress breaks for Thanksgiving.

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 when Obama holds his first face-to-face conversation with House Speaker John Boehner since the Nov. 6 election. At the White House meeting on the so-called fiscal cliff, Obama also will host 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.

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 limits on tax breaks 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.”

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.

Obama and congressional Republicans -- led by Boehner, an Ohio Republican -- are in a standoff over how to address the fiscal cliff. 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. 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.”

Treasury 10-year note yields traded yesterday in the narrowest range in six weeks. Yields were little changed at 1.59 percent at 4:59 p.m. New York time, according to Bloomberg Bond Trader prices. The Standard & Poor’s 500 Index fell 0.2 percent to 1,353.32 at 4 p.m. in New York, the lowest level since July 25.

 

2011 Negotiations

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.

Boehner and Obama, who tried to reach a deficit-reduction deal in 2011, will 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.

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.

“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.

 

Itemized Deductions

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.

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.

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.

 

‘Come Out Ahead’

“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.

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.

Representative Steve King, an Iowa Republican, said Boehner 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.”

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.

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.

 

Clinton-Era Levels

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.

Representative Chris Van Hollen, the top Democrat on the House Budget Committee, noted that Obama’s 2010 fiscal commission started with the assumption that the top rates would return to 36 and 39.6 percent.

“We’re saying, ‘Show us your math,’” Van Hollen said in an interview yesterday. “It’s hard to get there unless you start at a rate of 39 percent.”

Some Republicans see reason for optimism about an agreement based on the president’s remarks.

“I’m optimistic that the president left some room to negotiate,” said Senator Roy Blunt, a Missouri Republican.

Some say this is another chance at a budget deal. Former New Hampshire Senator Judd Gregg, a Republican and co-chairman of the Campaign to Fix the Debt, a non-partisan group urging deficit reduction, called this a “super opportunity” because “everybody’s cards are on the table.”

“The best way to resolve this whole thing would be for the president and speaker to sit down in a room by themselves and tell the staff to leave and draft out the parameters of the deal,” said Gregg, while acknowledging that such a circumstance is unlikely.

 

Bloomberg News

 

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