Analysis: At cliff's edge, old ideas to cap tax breaks are new again

By Kim Dixon and Kevin Drawbaugh

Mon Dec 31, 2012 3:57pm EST

n">(Reuters) - Imposing overall caps on how much high-income people in the United States can claim on their tax returns in deductions, exemptions and other tax breaks is an idea whose time may have come - again.

In the whirl of "fiscal cliff" talks, bipartisan backing has grown for imposing, or in some cases reinstating, caps on tax breaks for top earners.

On Monday, Republicans threw their support behind several approaches to do just that in a framework to step away from the fiscal cliff of $600 billion in new taxes and spending cuts set to take effect on January 1.

Under an emerging deal brokered by Republican Senate Minority Leader Mitch McConnell and Democratic Vice President Joe Biden, curbs on deductions and exemptions for households earning more than $300,000 would be re-imposed, according to a source close to the talks.

For several years, Democratic President Barack Obama has proposed re-imposing the limits. Republicans have opposed such caps for more than a decade, but the idea may be coming full circle.

These limits "were originally done in 1990 at the behest of the Republicans who didn't want tax rates to go up," said Michael Graetz, a Columbia University tax law professor and a former top Treasury Department official.

The main reason for the switch now? The urgent search for politically achievable paths to avoid falling off the fiscal cliff of sharp tax increases and spending cuts.

Talks on avoiding the cliff were moving along on Monday with the fresh offer from McConnell and Biden.

The beauty of the approaches, backers say, is that they let politicians raise government revenue without raising tax rates as much, said economists, Republicans and congressional aides.

Moreover, a strategy that caps several tax breaks broadly could be more expedient than trying to curb tax breaks one at a time that would incur the wrath of lobbyists who would fight them all the way.

Lawmakers are sizing up several ideas.

PEP AND PEASE

Two ideas backed by McConnell are reinstating the personal exemption phase-out (PEP) and so-called Pease limits on itemized deductions. Both were created in 1990 in a budget deal between Republican President George H.W. Bush and Democrats in Congress.

PEP and Pease - often viewed as a package deal - both reduce how much high-income taxpayers can claim in personal exemptions, in the case of PEP, and itemized deductions, in the case of Pease. Both measures work to raise taxes on top earners, without explicitly raising the tax rates that they pay.

When first imposed more than two decades ago, "they were ways to keep the rate at a certain level," Graetz said.

So how do they work?

PEP deals with the personal exemptions that taxpayers claim near the top of the Internal Revenue Service's Form 1040. Taxpayers claim exemptions for themselves, their spouses and their dependents. Last year, each exemption was worth $3,800.

The Pease limit - named after its author, former Ohio Democratic Representative Don Pease - applies to itemized deductions, such as the ones taken for mortgage interest, charitable giving and state and local taxes paid.

By reducing the values of exemptions and deductions, both PEP and Pease would work to raise the taxable income of wealthier people and, as a result, the taxes they pay.

Under a previous proposal offered by Obama, reinstating them would raise about $165 billion in new tax revenue over 10 years, the Tax Policy Center estimated.

Both limits were gradually eliminated under President George W. Bush. By 2010 they were history, a status which was extended for two years by Obama in an agreement with Republicans.

28 PERCENT CAP

Another idea is Obama's proposal to cap the value of tax deductions and certain tax exemptions for high-income taxpayers.

The president's proposal would limit the value of these tax breaks as one moves to a higher tax bracket. For example, a taxpayer in the current 35 percent tax bracket with $100,000 worth of qualified deductions and exemptions gets a $35,000 tax break. Under the 28 percent limit, that taxpayer would only get a $28,000 tax break.

Such a change would raise about $580 billion over a decade, according to a White House estimate, a significant chunk of revenue.

"Republicans have resisted it since the president proposed it," said Alan Viard, an economist at the conservative-leaning American Enterprise Institute think tank.

But a top Republican aide has said that House of Representatives Speaker John Boehner was willing to consider the president's proposed cap in budget talks with Obama.

Viard said that the idea fits with Republican support for broadening the tax base in exchange for lower tax rates.

There are limits already in place for some tax breaks, such as the $1 million limit for home mortgages.

(Editing by Howard Goller and Mohammad Zargham)

View the original article here

Analysis: After "fiscal cliff" dive, more battles, new cliffs

Macy Curtis, 11, and her grandparents Sam and Andrea Perrone, all of Snellville, Georgia, visit the U.S. Capitol in Washington, December 29, 2012. President Barack Obama and U.S. congressional leaders agreed on Friday to make a final effort to prevent the United States from going over the ''fiscal cliff,'' setting off intense bargaining over Americans' tax rates as a New Year's Eve deadline looms.

Credit: Reuters/Mary Calvert

By David Lawder and Fred Barbash

WASHINGTON | Sat Dec 29, 2012 4:26pm EST

WASHINGTON (Reuters) - Whether or not the "fiscal cliff" impasse is broken before the New Year's Eve deadline, there will be no post-cliff peace in Washington.

With the political climate toxic in Congress as the cliff's steep tax hikes and spending cuts approach, other partisan fights loom, all over the issue that has paralyzed the capital for the past two years: federal spending.

The first will come in late February when the Treasury Department runs out of borrowing authority and has to come to Congress to get the debt ceiling raised.

The next is likely in late March, when a temporary bill to fund the government runs out, confronting Congress with a deadline to act or face a government shutdown. The third will possibly be whenever the temporary bill replacing the temporary bill expires.

While Congress is supposed to pass annual spending bills before the start of each fiscal year, it has failed to complete that process since 1996, resorting to stopgap funding ever since.

Influential anti-tax activist Grover Norquist predicted in an interview with Reuters that conservatives would wage repeated battles with President Barack Obama to demand budget savings every time the government needs a temporary funding bill or more borrowing capacity.

The so-called "continuing resolutions" to which a divided Congress has increasingly resorted to keep the government operating, provide a "very powerful tool" to pry out spending cuts, said Norquist, president of Americans for Tax Reform.

Republican Senator Bob Corker of Tennessee said he will not be satisfied until there are substantial cuts to federal retirement and healthcare benefits known as entitlements, producing savings in the $4.5 trillion to $5 trillion range.

"Unfortunately for America," said Corker, "the next line in the sand will be the debt ceiling."

Most observers see the $16.4 trillion debt limit as the true fiscal cliff in the new year because if not increased, it would eventually lead to a default on U.S. Treasury debt, an event that could prove cataclysmic for financial markets.

The Treasury Department said on Wednesday it would start taking extraordinary measures by December 31 to extend its borrowing capacity for about two more months.

'POISONOUS CLIMATE'

It was a deadlock over raising the debt ceiling in August 2011 that prompted a deficit reduction deal that led to a key fiscal cliff component, the $109 billion in automatic spending cuts on military and domestic programs.

If the fiscal cliff's spending cuts or tax increases are left even partly unresolved on December 31, the political combat over them will carry over into the new Congress, possibly simultaneously with the debt ceiling debate.

"We would be pessimistic of a quick fix" if the deadline is missed, Sean West, head U.S. analyst at Eurasia Group, a political risk consultancy, said in a note to clients. "The political climate will be poisoned. The new Congress will need time to settle in."

"We are concluding one of the most unsuccessful Congresses in history," Democratic Representative John Dingell of Michigan declared in a statement on Saturday, "noteworthy not only for its failure to accomplish anything of importance, but also for the poisonous climate of the institution."

Dingell, 86, is the longest serving member of the House, elected first in 1955.

Historically, bitter struggles in Congress like that over the fiscal cliff lead to further resentment and strife in a cycle of cumulative grudges that now spans nearly 30 years.

Many analysts and lobbyists in Washington believe the strife could get even worse because the new Congress convening on January 3 will include fewer members from moderate or swing districts and more from districts tilted heavily to the left or the right.

Republicans in particular are likely to face their most serious re-election challenges in 2014 not from Democrats but from conservative Republicans challenging them in primary elections.

"Ironically," said a post-election analysis published by the law firm Patton Boggs, "the voters have elected a 113th Congress that may be even more partisan than the 112th."

(Reporting by David Lawder and Fred Barbash; Editing by Eric Beech)

View the original article here