PRESIDENTS choose their words carefully. So when Barack Obama talked of “tax reform” but not “tax rates” in his acceptance speech early Wednesday, he was presumably sending a signal. And it was similarly significant that later that day John Boehner repeatedly stated his opposition to higher tax “rates” rather than tax revenue.Within those two statements lies the nucleus of a deal: raising tax revenue through some means other than higher tax rates. There are myriad ways of doing this; the trick is to find one that both Democrats and Republicans can live with. (See update below.) During the supercommittee negotiations last year, Senator Pat Toomey proposed raising $250 billion in revenue over 10 years by closing loopholes. But he would also have cut rates sharply, which would have benefited the richest households most. That was anathema to Democrats; they wanted more revenue, but not if it made the tax system less progressive.
So the price for Democrats is that tax reform must be progressive: after-tax incomes of people at the top must be squeezed more than for people at the middle. Thus far, Mr Obama has equated that with allowing the top two income tax brackets to return to their pre-2001 levels. But there is an alternative route to the same goal that does not require higher rates, and it comes courtesy of Mitt Romney. Recall that when asked how he would pay for a 20% cut to marginal rates, he floated a cap on deductions, an idea proposed in 2011 by Martin Feldstein, Maya MacGuineas and Daniel Feenberg.
I don’t have a ready estimate of how much capping deductions for those earning more than $250,000 would raise. But you can ballpark it by looking the Tax Policy centre’s estimates for capping itemized deductions at $50,000. It would raise $749 billion over 10 years, within the $800 billion that Mr Boehner has previously agreed to. That’s also more than the $429 billion yielded from returning the two top rates to their pre 2001 levels. The appeal for Republicans is that no one’s rates go up, and the preferential rate for capital gains and dividends is preserved. The appeal for Mr Obama is that it is highly progressive. According to the TPC, less than 1% of the bottom 60% of households would pay more tax while the top 1% would pay 79% of the additional revenue. The average tax rate for the bottom 60% wouldn’t change, while it would go up 2 percentage points for the top 1%. It’s worth noting that Mr Obama’s budgets proposed capping the value of deductions for upper income households at 28%, which would have raised $584 billion over 10 years. Prior to 2001, the personal exemption and itemized deductions phased out for upper income taxpayers; those phaseouts were eliminated by the Bush tax cuts. Mr Obama’s budget would reinstate them, raising $164 billion over a decade. (These provisions would raise considerably less revenue if the two top rates did not go up.)
Would such a deal fly? One source close to House Republicans tells me: “I think they’d take it; they’re holding no cards at the moment… The capping of deductions would be very magnaminous and a good way to lay the groundwork for negotiating real tax reform.” But, he adds, “I don’t think Obama would offer that—why not fall back to Reid-Pelosi and increase it on people making over $1 million and dare house Republicans to walk away from that? Sacrificing the chance to earn political points will be very difficult for Democrats to do.”
On the other hand, Harry Reid and Nancy Pelosi, though unhappy to be excluded from Mr Obama’s grand bargain negotiations with John Boehner in 2011, seemed ready to fall in line with a deal that met Mr Obama’s conditions. So the bigger question is whether this sort of deal qualifies: is Mr Obama prepared to let the lower rates stay in place if he can get the revenue by other means? One former Administration official thinks he would: “Obama’s budget likes the idea of capping deductions at 28 per cent,” and this would be an even lower cap. “The problem is that it hurts both housing and charities. Both are powerful constituencies. And housing is fragile at the moment and phase-in would still roil real estate. Also at what level of income? Lots of Congressional Democrats want the bracket at $1 million, not $250,000.” He also thinks Democrats would want to raise rates on capital gains, which is a bigger deal to Republicans than income tax rates.Agreement on taxes constitutes only half of a deal. Republicans will accept higher tax revenue only if accompanied by spending cuts. Mr Obama is OK with cuts, but perhaps not the cuts to entitlements that Republicans want.
But it’s quite possible that the two could start out small with more modest caps on deductions and cuts to discretionary spending with cosmetic trimming of health care entitlements – enough to justify extending the lower tax rates for a year and delaying the sequester of automatic spending cuts. It would be a down payment on a more ambitious plan next year.
Both Mr Obama and Mr Boehner say they are not as far apart as people think. It’s encouraging that neither laid down markers that the other side can’t stomach; we’ll see if Mr Obama maintains that openness in an address on the economy scheduled for Friday. He has previously said he would reach out to Mr Romney for ideas; he could do worse than to adopt this one.
Update: Mr Obama today laid out his bottom line on any deal on the deficit: “If we’re serious about reducing the deficit, we have to combine spending cuts with revenue, and that means asking the wealthiest Americans to pay a little more in taxes. I refuse to accept any approach that isn’t balanced [in which] people like me, making over $250,000, aren’t asked to pay a dime more in taxes.”
The tone wasn’t exactly conciliatory: Mr Obama made sure to remind Republicans that taxes were heavily debated during the election campaign and “the majority of Americans agree with my approach.” (That was a slightly less brash than telling Eric Cantor, the Republican majority leader in the house, shortly after his 2008 victory that “elections have consequences.”) He also suggested the Bush tax cuts for those making less than $250,000 could be extended today without debate, something Republicans have steadfastly refused to do for fear of leaving all the leverage over the remaining tax cuts in Democrats’ hands. Mr Boehner quickly rejected that today. But from the standpoint of the coming negotiations, what was significant was what Mr Obama didn’t say. While raising the two top tax rates has figured in every one of his budgets and his submission to the super committee last year, today he never mentioned the words “tax rates.” He did say he was “not wedded to every detail of my plan. I’m open to compromise.” Brad Dayspring, a former Cantor aide, tweeted, “Listen carefully. There is certainly room for agreement between what Speaker Boehner said and President Obama said without increasing rates.”
However, Jay Carney, the White House press secretary, appeared to squelch that possibility. Asked a few hours after Mr Obama spoke whether the president would sign a package that does not restore the top two rates, he said, “The president would veto … any bill that extends the Bush Era tax cuts for the top two per cent of …earners in this country.”
Mr Boehner said he accepted Mr Obama’s invitation to the White House next week to begin discussions over the fiscal cliff. A resolution is still far off, but at least it’s not getting further away.
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