In the News

Deficit Talks Focus on Taxes; Democrats, GOP at Odds Over Raising Revenue as Negotiations Hit Critical Stage

July 5, 2011 — The Wall Street Journal — By John D. McKinnon And Carol E. Lee   Bookmark and Share

Democrats have floated ideas that could raise tax revenues by some $400 billion over the next decade as they negotiate deficit reductions with Republicans, according to people familiar with the plan, posing the most contentious issue as talks reach a critical stage this week.

Republican leaders say they want no tax increases in the deal, though some say they can accept ideas for generating additional revenue along with broader tax changes.

Democrats say significant tax increases are required for fairness, to offset the deep cuts to government services that will make up the bulk of deficit reduction.

One key question is what kinds of revenue measures Republicans might accept. A second is whether they will approve steps that raise the overall amount of tax revenue the government collects, or insist that new revenue additions be offset by tax cuts elsewhere.

Both sides agree that a deficit-cutting deal is required to win the votes needed in Congress to raise the nation's borrowing limit and avoid a default on government debt. Administration aides say an agreement must be reached by July 22 to give Congress time to draft legislative language and pass a bill ahead of Aug. 2, when the Treasury Department estimates that without a debt-ceiling increase the government will lose the ability to pay all its bills.

Seeking to pressure Republicans into accepting new tax revenues, Democrats including President Barack Obama last week focused on their proposals for narrowing current breaks that they say unduly benefit the wealthy.

"If we choose to keep those tax breaks for millionaires and billionaires, or for hedge fund managers and corporate jet owners…then we'll have to make even deeper cuts somewhere else," President Obama said in his weekly Saturday address.

As details emerge from the closed-door talks, however, it is becoming clear the tax plans on the table would go further. For instance, according to people from both parties familiar with the discussions, the administration's plan would cap itemized deductions for families with adjusted gross income, or income after certain deductions and other breaks, of $250,000 and up, not just those earning $1 million or more. And it would eliminate a tax-accounting methodology employed by a broad swath of U.S. businesses, including many small firms.

Republicans generally say government spending is the real problem, even as some say they are open to some "revenue increases," a term that has come to signify tightening of existing breaks. Americans "don't think they need their taxes raised, and I don't either," Sen. John McCain (R., Ariz.) said Sunday on CNN's "State of the Union." At the same time, Mr. McCain suggested willingness to consider "certain revenue raisers," without elaborating.

Senate Majority Leader Harry Reid (D., Nev.) invited Mr. Obama to continue talks on the debt ceiling this week, though on Monday details were still being finalized for a Wednesday meeting. Republican lawmakers didn't yet have scheduled plans for meeting with the president as of Monday, according to aides.

The biggest item on the Democrats' list also might be the most controversial: a cap on the value of itemized deductions for higher-income earners. The White House plan would limit the value of itemized deductions to 28% of affected income, instead of the current maximum of 35% (the top income-tax rate).

Democrats argue that high-income people unfairly benefit from any given tax deduction now more than middle-class people do, just because they are in higher tax brackets. The White House proposal would hit families earning more than $250,000, and individuals earning more than $200,000.

That proposal would raise about $290 billion over the next decade. Mr. Obama has made similar proposals before, but Republican aides term the idea a nonstarter. Some Democrats have floated the idea of raising the income threshold to $500,000 or $1 million instead.

A second proposal has gotten little attention but could have a big impact, ending a longstanding method of tax accounting for business inventories.

The last-in-first-out (or LIFO) method lets companies figure the cost of goods they have sold at the most recent market prices paid, even if they purchased the items at lower prices. Being able to list higher expenses makes a company's taxable income smaller. This change could bring in $60 billion or more over 10 years. LIFO supporters believe perhaps one-third of all U.S. businesses take advantage of LIFO, and they are fighting the repeal.

The administration also is pushing for repeal of a range of subsidies for the oil and gas industry. Mr. Obama says these breaks encourage over-investment in oil and gas and conflict with his clean-energy aims.

The major items include special expensing and depreciation rules for drilling and production, as well as a deduction for domestic manufacturing. Repealing these breaks for oil and gas producers could raise as much as $45 billion over 10 years. But versions of this idea already have been blocked or defeated in the Senate over the past year.

Another administration proposal would change the tax treatment of earnings for many investment-fund managers, ending a practice critics regard as unfair. Fund managers often receive an interest in the future profits of partnerships, in return for managing the investments. Under current rules, that share is taxed at capital gains rates, usually 15%, rather than the higher rate for wages.

Supporters of the current system say fund managers' partnership interest, known as "carried interest," is really an investment, not wages, and ought to be taxed as such. A similar proposal failed to pass the Senate last year despite lengthy negotiations. Mr. Obama's February budget proposal called for ending capital-gains treatment of carried interest for a range of "investment-services partnerships," not just hedge funds. The administration's latest proposal would raise about $20 billion.

Another proposal on the table would reduce a tax break for corporate jets, stretching the depreciation period to seven years from the current five years and raising about $3 billion over the next decade, according to unofficial congressional estimates. Aviation officials said it could hamper the hard-hit industry's recovery, but Mr. Obama and his team spent a lot of time talking up the idea last week.

"Ladies and gentlemen, we have a fight," Vice President Joe Biden said in a speech to Teamsters in Las Vegas on Friday, after describing how Republicans are resisting the tax increases.

On Fox News Sunday, Sen. John Cornyn (R., Texas) said, "The last thing that employers need is further disincentives to not hire people, and that's what higher taxes would mean."

Write to John D. McKinnon at john.mckinnon@wsj.com