A new bipartisan plan to reduce government borrowing would target some of the most cherished tax breaks enjoyed by millions of families — those promoting health insurance, home ownership, charitable giving and retirement savings — in exchange for lowering overall tax rates for everyone.
Many taxpayers would face higher taxes — a total of at least $1.2 trillion over the next decade, and perhaps more.
The details and impact of the plan, released this week by the bipartisan "Gang of Six" senators, emerged as President Barack Obama called congressional leaders to the White House on Wednesday to determine, in separate meetings, their bottom line for extending the nation's debt limit while also cutting spending at the greatest amount possible. The role of additional tax revenue remained a sticking point.
With the default deadline of Aug. 2 approaching, the White House signaled for the first time that Obama would be willing to sign off on a short-term extension of the debt limit if a grander deal were in the works and needed only a few days' worth of extra time to wind its way through the legislative process.
For its part, the Gang of Six plan punts on many of the most difficult issues, leaving it to congressional committees to fill in the details later. But supporters say it provides a framework to simplify the tax code, making it easier for businesses and individuals to comply while eliminating incentives to game the system.
"I think this is an attempt to find a middle ground on taxes that emphasizes keeping rates low and broadening the base as much as possible, and I think that's a very positive aspect of it," said Eugene Steuerle, a former Treasury official who worked on the last tax reform package that passed Congress, in 1986.
Coupled with spending cuts, the plan would reduce deficits by nearly $4 trillion over the next decade. While Obama and senators from both parties lauded the plan as a possible breakthrough in their negotiations, some congressional leaders said the plan lacks details and could produce much bigger tax increases than advertised.
"A tax increase is the wrong policy to pursue with so many Americans out of work," said House Majority Leader Eric Cantor, R-Va.
The plan would simplify the tax code by reducing the number of tax brackets from six to three, lowering the top rate from 35 percent to somewhere between 23 percent and 29 percent. That could provide a windfall for wealthy taxpayers because the 35 percent tax bracket currently applies to taxable income above $379,150.
To help pay for lower rates, the plan would reduce popular tax breaks for mortgage interest, health insurance, charitable giving and retirement savings. Other tax breaks would be spared, including the $1,000-per-child tax credit and the earned income tax credit, which helps the working poor stay out of poverty.
The alternative minimum tax, which was enacted in 1969 to make sure that high-income families pay at least some income tax, would be repealed. The tax was never indexed for inflation, so Congress routinely patches it each year — at an annual cost of about $70 billion — to prevent it from hitting more than 20 million middle-income families.
About 35 million households claimed the mortgage interest deduction in 2009, and about 36 million households claimed deductions for charitable contributions, according to the Joint Committee on Taxation, the congressional scorekeeper on taxes.
The Gang of Six plan does not specify how the tax breaks would be trimmed. Democrats have several proposals that would restrict wealthy families' use of the breaks, while preserving them for most low- and middle-income taxpayers. Such a plan would offset rate cuts for high-income families by limiting their ability to take advantage of various tax breaks.
For example, current law allows homeowners to deduct the interest they pay on home mortgages of up to $1 million. One proposal would lower the limit to $500,000 and exclude mortgage interest on second homes.
Starting in 2018, the new health care law would tax high-priced health insurance plans. There are several proposals to adjust the tax to include more health plans while sparing lower-income families with more modest coverage.
The Gang of Six plan is silent about taxes on capital gains and dividends, but tax experts said it would be difficult to generate more than $1 trillion in additional revenue without increasing taxes on investments. The current top rate on capital gains and dividends is 15 percent — well below the top rate for ordinary income.
"No matter what they do on the revenue side, by some measure they are going to be taking something away from somebody," Steuerle said. "The whole budget package is about asking a lot of people to give up something they think they have."
On the business side, the plan would lower the corporate income tax rate from 35 percent to somewhere between 23 percent and 29 percent, all of which would be funded by eliminating unspecified tax breaks for businesses.
Under current law, the U.S. taxes overseas profits of American corporations but only after they return those profits to the U.S. The proposal calls for a territorial tax system, which would tax only profits made in the U.S. The proposal could be a huge windfall for U.S.-based multinational corporations, though it would supposedly be financed by eliminating many of the tax breaks those same companies enjoy.
Business groups have already been lobbying Congress to keep their tax breaks and to create new ones, an effort that will only intensify if lawmakers dive into the details of overhauling the tax code.
"The bookshelves of policy analysts in Washington are loaded with statements of principle on tax reform that all sound good," said William Gale, an adviser to President George H. W. Bush's Council of Economic Advisers and now co-director of the Tax Policy Center. "And then they all die when you try to specify the details."
The Gang of Six senators is made up of Republicans Tom Coburn of Oklahoma, Mike Crapo of Idaho and Saxby Chambliss of Georgia and Democrats Kent Conrad of North Dakota, Mark Warner of Virginia and Dick Durbin of Illinois.