Debt-cutting plans share this: Taxes will go up for everyone

McClatchy NewspapersNovember 18, 2010 

WASHINGTON — Just in time to dash holiday cheer, a set of recently unveiled debt-reduction plans underscore how huge are the fiscal challenges facing the U.S. They also make clear how tough the tradeoffs must be to tame federal budget deficits and the national debt.

Major overhauls of the entire U.S. tax code are at the heart of all these plans. They'd eliminate popular deductions and radically change taxation across the board.

None of this will happen unless Congress and President Barack Obama enact these proposals into law. However, the gravity of the nation's debt problem and the stature of these commissions add political urgency to grappling with these proposals.

The most influential panel is the National Commission on Fiscal Responsibility and Reform. Earlier this month, the panel's two co-chairmen — Democrat Erskine Bowles and Republican Alan Simpson — released their preliminary report on how to bring down deficits and debt. It sent shock waves rumbling nationwide.

"We can't grow ourselves out of this problem. We can't tax our way out of it," Bowles told PBS' Charlie Rose Tuesday. "People who want to do just taxes, you'd have to raise the maximum marginal rates to 80 percent. You'd have to raise the corporate rate to 70 percent. You'd have to raise the capital gains rate to 50 percent if you're just going to do taxes.

"We can't cut our way out of it. People say, "Oh, well, let's just cut the budget." If you just rely on deficit reduction through cutting, and you want to exclude Social Security, Medicare and defense and of course interest, then you'd have to cut everything else by about 60 to 65 percent. You can't do that, either," Bowles said.

"What we've got to do is some combination. Alan and I have come out with a plan that's balanced that takes $4 trillion out of the deficit over the next 10 years. I think that's the kind of thing we have to do. And if we don't, the markets are going to force us to."

Their report drew cautious praise from moderates and conservatives, but many liberals insisted instead that reducing unemployment, not deficits, should be the government's most urgent priority.

Budget experts disagree.

"Some politicians and economists present a false choice: Reduce unemployment or stabilize the debt. Restoring America's future, however, requires that we do both — and begin now," said a second similar report this week from the Bipartisan Policy Center, a think tank featuring former Washington leaders from both parties.

A third similar report was issued jointly this month by the Peter G. Peterson Foundation, which is devoted to reducing the national debt, and the Pew Charitable Trusts.

Driving all the plans is this cruel reality: The federal deficit is projected at $1.3 trillion this year, almost as much as last year — a scale not seen since the end of World War II. Left untamed, experts insist, this monstrous debt threatens the nation's future prosperity and security. Simply paying interest on the nearly $14 trillion national debt will cost more than $1 trillion in 2020 — 17 percent of all federal spending — unless big changes are made.

The biggest change that all three plans emphasize: Overhauling the U.S. tax code. All three plans would restructure income tax brackets. Current tax brackets_ set to sunset this year — are 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. The corporate rate is 35 percent.

All three plans would broaden the tax base subject to the lower rates to ensure that sufficient revenue comes to the Treasury. They'd do that by eliminating or limiting popular tax deductions, such as those for interest paid on mortgages and for charitable donations.

Bowles-Simpson suggests three individual income-tax rates — 8 percent, 14 percent and 23 percent. It also would drop the corporate tax rate to 26 percent.

An alternative option would establish three rates at 15 percent, 25 percent and 35 percent.

The policy center proposes only two income-tax brackets, 15 percent and 27 percent. Its corporate rate would also be 27 percent.

In the final accounting, almost everyone would pay higher federal taxes under Bowles-Simpson.

"In 2015, the lowest earners would face an average cut in their after-tax income of 3.4 percent, or about $400. Middle-income households (those earning an average of about $60,000) would see their after-tax incomes fall by 4 percent or about $1,900," according to analysis by Howard Gleckman, a researcher at the Tax Policy Center, a joint operation of the Brookings Institution and the Urban Institute, two leading Washington policy research centers.

The wealthiest 1 percent would see their after-tax income shaved by $77,000, Gleckman wrote, while the top one-tenth of 1 percent of earners would see after-tax income fall by 8 percent, or almost $500,000.

In short, everyone would share the burden of reducing the debt, some more than others.

"Some individuals and corporations will certainly pay more, being the heavy users of deductions, and that's what makes tax reform so hard," said Rudolph Penner, a former director of the Congressional Budget Office and now a senior fellow at the Urban Institute. "There are a large number of losers, and they always seem to howl louder than those who praise the tax reform."

Many of the proposals are certain to be controversial, none more than one featured by all three plans — a sharp reduction in popular mortgage-interest deductions.

Mortgage holders now can deduct from their federal income taxes the amount of interest they pay on any outstanding mortgage debt of $1 million or less.

Under Bowles-Simpson, this deduction could be reduced by 20 percent, or by 15 percent under a second option.

Under a third option, some interest costs would be excluded from the deduction: interest paid on mortgages for vacation and/or second homes; interest paid on home equity loans; and interest on any mortgage valued above $500,000.

The Bipartisan Policy Center would eliminate the entire mortgage-interest deduction. It would replace it with a 15 percent tax credit for interest expenses on a mortgage for principal residences only. The tax credit would be capped at $25,000.

Taxpayers no longer would file a tax return to claim the credit; it would be applied by mortgage lenders, who'd lower a borrower's annual mortgage interest payments by 15 percent.

The Peterson-Pew report would replace the mortgage-interest deduction with a 20 percent tax credit. It estimates this would reduce the deficit by $190 billion by 2018.

Real-estate interests don't like these proposals.

Walter Molony, a spokesman for the National Association of Realtors, said his group "is opposed to any change in the mortgage interest deduction, and will make an assessment when definitive proposals are released."

"The mortgage interest deduction is one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain," Michael Berman, the chairman of the Mortgage Bankers Association, said in a statement.

Other tax proposals also promise to be unpopular, at least when viewed in isolation rather than as components of national debt-reduction.

Among them: Bowles-Simpson would impose a 15-cents-a-gallon federal gas tax to fund road and bridge projects.

For the employed, both Bowles-Simpson and the policy center would end the practice of not taxing the value of employer-provided health insurance.

In addition, if an employer health-insurance plan is valued above the standard plan that most federal workers have, Bowles-Simpson would tax the difference in value. Currently, employees' health care premiums are deducted from their checks before taxes, lowering their taxable income.

Business interests and investors would have to pony up too.

Capital gains would be taxed at the rate of ordinary income, not the current 15 percent rate.

Businesses would lose deductions such as writing off the declining value of equipment. Under Bowles-Simpson, corporations could still count on a tax credit for research and development.

Even so, the U.S. Chamber of Commerce issued a positive reaction.

"The U.S. Chamber is encouraging the entire business community not just to calculate the cost of specific deficit reduction proposals to their individual companies, but to weigh the long-term costs to our country, our economy, and future generations if we fail to act," Martin Regalia, the group's chief economist, said in a statement. "All solutions will require shared sacrifices and we must be prepared to make them."

ON THE WEB

Bowles-Simpson Plan

Bipartisan Policy Center plan

Peterson-Pew plan

Charlie Rose interview with Bowles and Simpson

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