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What a Tax Deal Might Look Like What a Tax Deal Might Look Like

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Magazine / ANALYSIS: BUDGET

What a Tax Deal Might Look Like

A new emphasis on revenue, rather than rates, indicates that some grounds exist for a fiscal-cliff-averting compromise.

photo of Nancy Cook
November 15, 2012

President Obama and congressional leaders have laid out the parameters of a compromise on taxes, even if it’s not immediately apparent underneath their heightened partisan rhetoric this past week.

That compromise starts with the simple word “revenue.”

Revenue is the money flowing into the federal government. Talking about “additional revenue” does not specify where that money must come from—higher tax rates on individuals or investment income, or caps on tax deductions, or the closing of loopholes, or even a comprehensive overhaul of the tax system.

 

White House press secretary Jay Carney hinted at the newfound flexibility during a Tuesday press briefing. He indicated that although the president already put forth a budget plan, “he is not wedded to every detail.” This leaves “revenue,” as broad as this term is, as one of the few signs of hope that Congress might reach a deal before the fiscal-cliff deadline of Jan. 1.

“One thing that makes me a little sanguine is that after the election, there is less to be gained by painting the other side into a corner; 2013 is not an election year,” says Joshua Feinman, chief global economist at DB Advisors.

One possible compromise between the two parties could come from limiting tax deductions—an idea that gained traction this week and has been sanctioned by everyone from Mitt Romney and others in the GOP to Democratic leaders such as Sens. Dick Durbin and Max Baucus.

Limiting tax deductions isn’t a new idea. Harvard-based economist Martin Feldstein has proposed capping the deductions that taxpayers could collect at 2 percent of adjusted gross income. Romney put forth a fixed dollar cap, somewhere between $17,000 and $50,000. And, in past budgets, President Obama has suggested limiting the value of itemized deductions and tax expenditures to 28 percent, although the idea has never gone far in Congress.

“It’s very difficult to see how you make up that trillion dollars. ” —President Obama

A big problem is that limiting deductions for high-income earners, as the president has proposed, won’t, by itself, raise enough to satisfy the president’s opening bid this week for $1.6 trillion in new revenue. The most restrictive cap in Romney’s plan of $17,000 in deductions could raise as much as $1.7 trillion over the next decade if it is applied to all taxpayers, according to an analysis by the Tax Policy Center. But limiting the cap to high-income households above the $250,000 threshold reduces the amount of money the federal government could collect to roughly $573 billion over the next decade, the Treasury Department estimates.

“It’s very difficult to see how you make up that trillion dollars, if we’re serious about deficit reduction, just by closing loopholes and deductions,” Obama said at a press conference on Wednesday. “The math tends not to work.”

Another option for adding revenue could be increasing taxes on investment income. The House Ways and Means and Senate Finance committees held a joint hearing recently on  the future of capital-gains tax rates. An added attraction of this idea, at least for liberals, is that it directly hits the wealthy and thus fits into Obama’s tax-the-rich campaign narrative.

Currently, capital gains and qualified dividends are taxed at a rate of 15 percent. On Jan. 1, those rates are scheduled to increase to 20 percent for capital gains and a top rate of 39.6 percent for dividend income. Treasury estimates that these increases would net the federal government $242 billion over the next 10 years.

Third Way, a centrist Democratic think tank, calculates that raising both tax rates to 20 percent, as some of president’s previous budgets have suggested, would bring in $130 billion over 10 years. That’s less dough, but it would actually come from the rich. The Tax Policy Center estimates that 75 percent of
the benefits from low rates on capital gains and qualified dividends go to the top 1 percent of taxpayers.

Increasing these rates to some middle ground would allow both parties to save face on the tax issue. The Republicans could sell it as a triumph because it doesn’t raise individual tax rates, and the Democrats could treat it as win because it would truly target the well-off, not middle-class salaried workers.

Infographic

The final plank in the revenue compromise could come from flexibility on raising the upper income-tax rates. Vice President Joe Biden seemed to signal some wiggle room on the Democrats’ position during his debate with Paul Ryan, when he repeatedly referred to raising taxes on “millionaires.” He said it enough times that it seemed unlikely to be merely a Biden gaffe.

Democrats such as Sen. Chuck Schumer and House Minority Leader Nancy Pelosi have also supported the idea of increasing taxes only on household income above $1 million, while Senate Finance Committee Chairman Baucus has indicated that the top tax rate should fall somewhere above 35 percent but not as high as the president proposed. Baucus has yet not provided a suggested alternative figure.

Moving the definition of an upper-income earner to the higher mark would cost the government potential revenue (as much as $366 billion over the next decade, says the Center on Budget and Policy Priorities). But, politically, it seems like a viable option when paired with some combination of other sources of additional money. For one thing, the idea enjoys broad-based support among the American public, and it could be easy to conceptualize when selling an overall package. But whether Republicans are willing to bend at all on individual income rates remains to be seen.

The real movement on revenue, as well as other fiscal-cliff issues, will have to wait until after Thanksgiving. For now, conversations are going on only behind closed doors and only among a handful of top staffers in the Senate, the House, and the administration. But the fact that the Democrats and Republicans keep talking about revenue in a broad manner, as opposed to tax rates, leaves room for a deal. If and when they revert to harping solely on tax rates, it will be a sure sign that negotiations have soured. 

This article appeared in print as "Maneuvering Room."

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