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.

Add to Briefcase
Nancy Cook
Nov. 15, 2012, noon

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.

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.”