PULSE: In the News

Next Year

By: Martin Frost, Guest Contributor to The Hill

Clearly one of the biggest challenges for the Obama administration and Congress next year will be what to do about deficit reduction. It is complicated and very hard. Let’s take an initial look at some of the challenges.

Lots of new and returning House and Senate members campaigned on doing something about the deficit, and the president’s deficit reduction commission made some sweeping recommendations. Certainly the president will address this in his State of the Union message in January, and probably in his budget to be delivered to Congress in late January or early February.

Here are the problems as I see them.

The problem might not be as great on the spending side as it will be on the tax side, though spending cuts will be controversial. Any real deficit-reduction package must address both spending and taxes and must include some additional tax revenue.

The deficit reduction commission made a tax proposal that on the surface generated some support from both Democrats and Republicans; however, good luck in ever implementing it.

The panel’s proposal was to lower both personal and corporate rates to about 28 percent (from existing 35 percent rates) and to eliminate virtually all personal and business deductions (except ordinary course-of-business expenses). The panel predicted that this approach would not only pay for lower rates but also provide enough additional revenue to help pay down the deficit.

The national press was so overwhelmed by the complexity of the panel’s recommendations that it really didn’t pay sufficient attention to the landmines in the tax recommendations.

Among the landmines that could derail this entire approach are the following:

Change the charitable deduction from an itemized deduction (worth a lot of money to high-end tax payers and to charities) to a limited credit. This credit would be worth 12 percent of the amount contributed after taking a deductible of 2 percent of adjusted gross income. Wait till the churches, charitable foundations and nonprofit institutions like hospitals and universities weigh in on this one. Not a snowball’s chance in hell that this will ever become law.

Change the mortgage interest deduction from an itemized deduction to a credit equal to 12 percent of the amount of interest paid. This would apply to mortgages under $500,000. Converting this from an itemized deduction to a credit would reduce the value of the current deduction for most homeowners by about 50 percent. The homebuilding and real estate industries will fight this to the death.

Eliminate all special treatment for capital gains and dividend income. Right now both are taxed at 15 percent and under the proposal would be taxed as ordinary income rates (35 percent in the top bracket). The stock market and corporate executives (who receive much of their income in stock and dividends) will hate this one.

Eliminate all tax preferences for the domestic oil and gas industry (percentage depletion and intangible drilling costs are key examples). This would have the effect of depressing domestic exploration and increasing our reliance on imported oil. Need I say more?

Make significant changes in the way foreign source income is taxed for multinational companies. This one is so complex that it, by itself, it could tie Congress in knots for years.

I have just scratched the surface. There was a lot of happy talk about the deficit reduction panel’s recommendations when they came out. It is highly unlikely that Congress, in the end, will have the stomach to take on all these and other complicated tax issues, and, without a tax component, deficit reduction is not a serious undertaking.

Should Congress spit the bit on these tax changes, it will have to seriously examine a value added tax (VAT). That is a horse of a different color and will generate its own controversy.

Good luck to my friends on Capitol Hill. Deficit reduction is not impossible, but it is really, really hard. No one should pretend otherwise.