Balancing Act VI: Supercommittee solutions

Congress and the president have dumped the nation's fiscal problems into the lap of a dozen lawmakers on a supercommittee, which may well come up empty-handed. But the solution really isn't so hard. Just cut entitlements, and raise revenue by eliminating tax breaks. And let's go bold on corporate taxes and capital gains.

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Sixth in a series

With no movie superhero to rescue the federal government from the fiscal abyss, Congress has turned instead to a supercommittee. Its six Republicans and six Democrats can't leap gaping budget holes in a single bound, but the nation is looking to them to map a bipartisan course back to solid financial ground.

This week the committee crossed the Rubicon.

Republicans put a plan on the table that included raising tax revenue by plugging loopholes. Democrats have long accepted that cuts in Medicare, Medicaid and Social Security must be a part of deficit reduction, but wouldn't support cutting those programs unless taxes were increased in the bargain. After months of bitter stalemate on taxes, Republicans have joined Democrats in recognizing there can be no sacred cows, no matter the political cost.

That's real progress. Problem-solving pragmatists -- those neither blinded by ideology nor obsessed with partisan advantage -- know it will take both cuts in entitlement spending and additional tax revenue to tame federal deficits. And it comes not a moment too soon. The national debt topped $15 trillion this week for the first time.

Striking a deficit reduction deal in the hyperpartisan, election-year environment is still a long shot. But in another encouraging sign, congressional leaders this week rejected talk of disarming the trigger of $1.2 trillion in automatic cuts in defense and domestic spending, beginning in 2013, if the committee or Congress fail to adopt a deficit-cutting plan.

Eliminating the trigger would be unbelievably irresponsible -- and an abject admission that Congress can't meet the nation's challenges. Financial markets would react negatively to that surrender, which could provoke another downgrade in the nation's credit rating.

 

Start with tax reform

With a Nov. 23 deadline for the supercommittee to pass a plan to trim deficits by at least $1.2 trillion over a decade, the place to start is income tax reform. The committee should be bold.

It should simplify the tax code, lower rates and raise revenue by eliminating loopholes. But it should also eliminate the corporate income tax and tax capital gains the same as income from work.

The latest Republican proposal would raise $300 billion in new tax revenue over 10 years by limiting deductions. But it would also make the Bush tax cuts permanent and lower the top tax rate from 35 percent to 28 percent, which together would deprive the treasury of about $3 trillion it could otherwise collect to mitigate spending cuts or reduce deficits.

That falls far short of the amount of new tax revenue needed to attack the mountain of deficits and debt. Democrats floated proposals for as much as $1 trillion in taxes over 10 years in a higher-stakes bargain to cut deficits by far more than the $1.2 trillion target.

That's a huge gulf to bridge between the revenue increases envisioned by Democrats versus Republicans. And ending the low, 15 percent tax rate on long-term capital gains and dividends, as well as the corporate income tax, would be a tough sell politically.

The public will demand to know, why give corporations the mother of all tax breaks when they're making big profits and working people are hurting?

The answer is it would provide a powerful incentive for companies to invest in the United States. That would drive economic growth and job creation.

The corporate tax produces relatively little revenue -- $191 billion in 2010 compared with $899 billion from individual income taxes and $865 billion from payroll taxes.

Eliminating it would simplify the tax code. The current 35 percent corporate rate encourages herculean efforts at tax avoidance. Corporations employ legions of accountants and lawyers to design loopholes, and use campaign contributions and lobbyists to ease those loopholes into law. And it works. Some profitable corporations, famously General Electric Co., paid zero federal income taxes in some years. That preferential treatment undermines confidence in government. It's time to end the game.

At the same time long-term capital gains should be taxed as ordinary income, which would be a tax increase for wealthy investors. One reason historically for the preferential treatment was to make allowances for double taxation. Corporations are taxed on their profits and then those profits are taxed again as capital gains realized by shareholders. Eliminate the corporate tax and you eliminate that rationale for the lower capital gains rate.

 

Raise the capital gains tax

Taxing capital gains and dividends as ordinary income would make the system more progressive. Wealthy investors would pay at individual rates, currently up to 35 percent, rather than 15 percent. Those with lower incomes would pay lower rates.

The change would also end one of the most indefensible loopholes ever contrived for the superrich: A break for hedge fund and private equity fund managers whose billions of dollars in fees, called "carried interest," are taxed as capital gains, even when fund managers risk none of their own money.

Most middle-income taxpayers wouldn't be harmed by raising the capital gains tax. Their investments are largely in 401(k)-style retirement accounts, and that money is already taxed as ordinary income when withdrawn.

The supercommittee can only point the direction to deficit reduction through revenue-producing tax simplification and spending cuts. Congress will have to make the trip. But the goal should include boosting economic growth, which is the best deficit-fighter.

 

Sunday: Series conclusion

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