Debt Ceiling: The Tax Question

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What tax changes might emerge from the slugfest now roiling Congress over raising the U.S. debt limit?

Compromise thus far has proved elusive: So spirited did debt negotiators' eye-gouging and nose-pulling become, that the Chaplain of the Senate had to offer up a prayer asking for bipartisanship.

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"They're going to raise the ceiling—that's for sure," predicts Lance Roberts, CEO and chief economist for Streettalk Advisors, a Houston investment firm. "There's no way around it." Beyond that, however, everything else is hard to call.


"It's easier to say what the changes won't be," thinks Stan Collender, an expert on the federal budget process and a partner at Qorvis Communications in Washington, D.C.. "There won't be an increase in tax rates." To propose otherwise would be, for Republicans, "like putting a red flag in front of a bull. It would stop the whole process dead in its tracks." Changes classified as "revenue enhancers," Collender thinks, stand a chance.

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Roberts questions how much of real consequence is likely to emerge--changes that would affect the average taxpayer. Reason? The real budget fight, he believes, will wait until the next election.

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He accepts the fact that eliminating a variety of tax deductions would help balance Uncle Sam's books. But the ones that would contribute the most revenue, he believes, are politically untenable. Eliminating, say, the deduction for mortgage interest, "would show a big impact on the revenue side. But it's a non-starter because too many home owners are struggling already."

A non-starter, too, is anything labeled a tax hike.

That doesn't mean negotiators might not agree on changes that would pluck money from taxpayers' pockets, only that such changes would be called something other than a tax. For example, agreeing to change the way the government calculates inflation "could reduce the payouts to recipients of Social Security" and other government entitlement programs.

Mitch McConnell's Last Choice Option

Roberts thinks negotiators, instead of going after big game like Social Security, will instead train their fire on targets politically more vulnerable, where the symbolism is rich even if the gain in revenue is small---eliminating tax breaks for owners of corporate jets, say, or for hedge funds or for Big Oil. While such changes would mean next to nothing to the average taxpayer, they could result in a drop in dividends for people owning the affected stocks or in job losses for workers in those industries.

"The Rich"--people earning over $250,000 a year—likewise are vulnerable, says Roberts: "If there's going to be a tax increase, that's where it will happen. This may be the ground the GOP gives up."

Economist Leonard Burman, who teaches tax policy at the Maxwell School of Syracuse University, thinks debt negotiators might re-visit an idea proposed last year by the Bipartisan Policy Center's Debt Reduction Task Force: converting tax deductions into credits. The three biggest deductions—those for home mortgage interest, state and local taxes, and charitable contributions--could be re-cast as credits.

A homeowner, for example, would no longer be able to deduct mortgage interest. He would instead receive a flat 15 percent credit for home mortgage interest expense on a principal residence up to $25,000. He would not have to file a return to get the credit, which would go directly to the mortgage lender. The lender in turn would pass along the credit to the home owner in the form of a 15 percent reduction in interest payments.


People donating to charity likewise could not deduct their gifts. Instead they would qualify for a flat 15 percent credit, which would be paid directly to the charity by the IRS. A taxpayer wanting to donate $100, say, would make an $85 gift. And the charity would get an additional $15 from the IRS, in the form of a matching grant.

Such credits, argues Burman, are intrinsically fairer than tax deductions, since everyone who files taxes would get a credit but currently only the one-third of filers who itemize qualify for deductions.