November 14, 2012 7:02 pm

Cap on US tax breaks back on table

Some of the most popular US tax breaks, including on mortgages and charitable donations, could be limited for wealthy Americans in a bid to avert the fiscal cliff as a compromise between Republicans and Democrats on raising revenue.

President Barack Obama has long supported reducing tax deductions for the rich from 35 per cent to 28 per cent, which would save $574bn for the US government over a decade. However, this plan failed repeatedly to advance in Congress amid steadfast Republican opposition and some Democratic scepticism as well.

Yet a cap on tax deductions is firmly back on the table as negotiations heat up to strike a budgetary deal to prevent a flood of tax rises and spending reductions scheduled for January 1, which could lead to a new US recession.

An agreement may not take the form of Mr Obama’s proposal, but Republicans have been coming around to the idea. This is because it could be a way of taxing the rich more aggressively – as Mr Obama is demanding – without raising tax rates on wages, capital gains or dividends, which Republicans continue to resist.

“There are a number of devices we could use to get there,” says Pat Toomey, a Republican senator from Pennsylvania. “My preference is to limit the total of itemised deductions as one of the main vehicles that would generate offsetting revenue.”

As well as the White House plan, a cap on tax deductions could also be structured as a share of household income, as Martin Feldstein, a top economic adviser to Ronald Reagan, the former Republican president, and Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget, have suggested.

Mitt Romney, the Republican presidential nominee defeated by Mr Obama, proposed a fixed dollar amount ranging between $17,000 and $50,000 that would allow taxpayers to choose which tax breaks to keep and which to lose.

But big obstacles remain. The first one is that for many Democrats and the Obama administration the priority is still to extract higher income tax rates on the rich and they see capping deductions as a complement, not a substitute, for that. This is because they worry it would not raise enough revenue unless it hit the middle class as well as the wealthy. “There is a lot of magical thinking about how much money you can raise from tax expenditures [deductions],” said Tim Geithner, Treasury secretary, this week.

Another problem is that lobbying pressure to stop such a policy will be extremely intense from industries and sectors that benefit from these tax breaks, with housing and charity advocates on the front lines. “Even if it’s proposed, there’s going to be a groundswell of support that you shouldn’t balance the budget on the backs of charity,” says Eileen Heisman, president of the National Philanthropic Trust. She says this is particularly true at the time of economic and fiscal hardship, in which government resources are strained and more people need help.

In depth: US fiscal cliff

The White House and Congressional leaders are embarking on high-stakes talks to avoid a looming fiscal cliff

The National Association of Realtors, which represents agents in the property sector, has also expressed concern. Gary Thomas, the group’s president, says though there are no specific proposals to discuss, the mortgage interest deduction will be defended. “[It] is vital to the stability of the American housing market and economy and we will remain vigilant in opposing any future plan that modifies or excludes the deductibility of mortgage interest,” he says.

The discussion of tax deductions comes amid a sweeping debate within the Republican party over whether to yield to Mr Obama on higher taxes, and under what conditions.

Ron Johnson, a senator from Wisconsin, says he is worried Republicans might waver on their commitment not to raise taxes and “cave [in] to the political demagoguery of punishing success”.

He adds: “I’m highly concerned. I think it’s short-sighted. In these types of situations people end up doing what may be politically expedient as opposed to really standing high on principles.”

But Mr Toomey says it might be a necessary evil. “Raising taxes doesn’t solve the problem, so I don’t think it’s necessary nor is it optimal to have any kind of systemic revenue increase, I’m simply acknowledging that there is a political reality here. Unfortunately, we lost,” he said.

“The president is insisting some people pay higher taxes or he won’t address the underlying problem. Because the underlying problem is so acute and so imminent . . . we might very well have to do it.”

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