Supercommittee’s Kryptonite Was Taxes

The congressional supercommittee called it quits this week only a couple of days before its November 23 deadline, unable to reach a consensus on either taxes or spending cuts.

The 12-member committee, officially known as the Joint Select Committee on Deficit Reduction, had been charged with coming up with a plan to trim the national debt by $1.2 trillion over 10 years’ time as part of last summer’s deal to lift the debt ceiling. Equally composed of Democrats and Republicans from both the House and Senate, the supercommittee’s mission was practically doomed from the start when several anti-tax hardliners were appointed (see Deficit Supercommittee Throws in the Towel).

They effectively resisted any efforts to include tax revenue increases as part of the solution to curbing the spiraling budget deficit and national debt. That is, until about two weeks ago, when Republicans on the committee reportedly proposed about $300 billion in tax revenues as part of the deal. Those would be generated by eliminating or limiting many popular deductions, such as for mortgage interest and state and local taxes, in exchange for lowering the top tax rate from 35 to 28 percent (see Congressional ‘Supercommittee’ Takes on Tax Reform).

However, Democrats on the committee countered with their own plan that would more evenly balance tax increases with spending cuts while avoiding the lowering of overall tax rates. The two sides were never able to agree on the issue of taxes, and they finally admitted defeat on Monday, two days ahead of the November 23 deadline. The deadline was effectively Monday anyway, because they would have needed to get a “score” from the Congressional Budget Office on the numbers in their plan before they could submit it to their colleagues in Congress for an up or down vote.

Congress was supposed to be able to vote on the plan by the end of the year without making any amendments. Now, without any plan to vote on, under the debt ceiling deal, automatic spending cuts of $1.2 trillion are supposed to be triggered in 2013, divided equally between defense and discretionary spending programs. Some members of Congress now want to change that part of the deal, known as “sequestration,” especially in terms of the defense budget cuts, which are estimated to affect about 10 percent of the military’s budget. But President Obama has already told Congress that he would veto any attempt to weasel out of the automatic spending cuts.

One way or another, $1.2 trillion will be cut out of the budget over 10 years, on top of the $1 trillion that was supposedly cut as part of the August debt ceiling deal. Still, it’s likely that we will continue to see a lot of jockeying going on over the course of the next year and probably beyond, on where those cuts will fall. Senators John McCain, R-Ariz., and Lindsey Graham, R-S.C., have already said they plan to introduce legislation to lessen the cuts in the military budget. With the Presidential election season underway, the automatic spending cuts have already become a topic of debate among the candidates.

It is also likely that the tax reform efforts in Congress will play a role in the deficit reduction talks. Now that the supercommittee has given up on its task, it falls to Congress’s traditional committees, including Appropriations, Budget, Finance, and Ways and Means, to come up with a way to carry out the debt ceiling deal in coordination with the Obama administration.

On the House side, the Ways and Means Subcommittee on Select Revenue Measures held hearings last week on setting up a “territorial” tax system that would tax corporations only on the profits they earn in the U.S. (see Congress Mulls Territorial Tax System). The Senate Finance Committee has also been holding a series of hearings in the past couple of years to examine various aspects of tax reform for both individuals and corporations.

Another idea that may catch on, according to alliantgroup national managing director Dean Zerbe, is one proposed by Harvard economist Martin Feldstein and some of his colleagues at the National Bureau of Economic Research that would limit the amount of itemized deductions that high-income taxpayers could claim. Several Republicans on the supercommittee reportedly supported this approach. The advantage of such an approach is that it would not raise any of the marginal tax rates or eliminate any tax deductions, thereby avoiding the stigma of a “tax increase” and perhaps a backlash from Grover Norquist and his group Americans for Tax Reform.

We may see some of these ideas incorporated within the deficit reduction plan that eventually comes out of Congress. But in the midst of a Presidential election season, it will be difficult for Republicans and Democrats to reach a compromise that doesn’t make either party look bad with their core constituents. The eventual spending cuts won’t take place until 2013 at the earliest and by then the election will be decided. Thus, we can expect some tinkering with them around that time, whatever gets decided next year.

And don’t forget that last December’s extension of the Bush tax cuts will also expire at the end of next year, so we can expect another election issue to be the fate of those tax rates, especially for taxpayers earning $250,000 or more. If Congress and the Obama administration can’t reach a deal on those by the end of next year, it will be up to whichever party is in control in 2013 to decide what combination of tax revenues and spending cuts will help restrain the budget deficit without choking off economic growth.

If the 12-member supercommittee couldn’t reach a deal this year, the prospects for a deal between the hundreds of Republicans and Democrats in Congress, the Obama administration, and perhaps whoever gets nominated on the Republican side are not going to be any brighter next year. At least we know they will be able to agree to pardon a turkey for Thanksgiving.