'Fiscal cliff' negotiations just a first move in tax code overhaul

Whatever the White House and Congress may work out to avert the "fiscal cliff," it would be just a downpayment on a wider tax overhaul -- and don't think the middle class is going to escape unscathed in the broader deal.

For years, the nirvana of tax reform has been the flat tax. In the '90s, Steve Forbes was a vocal proponent of an across-the-board 17 percent tax on all personal and corporate earned income during his short-lived presidential bid. More recently, Herman Cain touted his 9-9-9 proposal: a 9 percent income tax, a 9 percent business transactions tax and a 9 percent federal sales tax that eventually would become a 0 percent income tax, 25 percent corporate income tax and 15 percent federal sales tax. No separate Social Security or Medicare levies.

The odds on adopting any flat-tax proposal are long. It would need to eliminate all deductions and loopholes, each of which is coveted by one constituency or another.

Three of the most popular -- and expensive from the government's point of view -- are the mortgage interest-state property tax, charitable giving and retirement savings deductions/shelters. Analysts predict all are likely to be cut in any tax overhaul.

The mortgage interest deduction costs the federal government $86.9 billion a year. Couple that with $50.7 billion for property taxes and you've reduced the federal budget deficit by more than 10 percent if both go away. Charitable giving? $50 billion.

Those deductions might save the feds $181.6 billion, but at what cost?

The real estate industry says eliminating the mortgage and property tax deductions would devastate the housing industry at a point when it's just beginning to recover from the recession.

The National Association of Realtors predicts elimination of the mortgage interest-local property tax deductions would reduce home equity 15 percent and in time lead to a loss of 250,000 to 350,000 jobs because people who buy new homes also need appliances, carpeting and other items, making up 20 percent of the gross domestic product. Instead, NAR suggests, cap the deduction and just eliminate it for second homes.

Bob Pozen, senior fellow at the Brookings Institution, has suggested a $500,000 cap on mortgages eligible for the deduction or a tax credit for homeowners who don't itemize earning $50,000 to $100,000, World Property Channel reported.

Those involved with non-profit organizations say eliminating the deduction for charitable giving threatens to choke off the $300 billion donated annually, drying up needed resources for those least able to make it on their own.

"If this benefit goes away, who's going to pick up the slack?" asked the Rev. Larry J. Snyder, president of Catholic Charities USA, in an interview with The New York Times. "Definitely not the government. It's the only deduction that directly impacts community benefit. Cutting it -- it defies the logic of cutting, I think."

The White House last week pretty much nixed eliminating the deduction for charitable giving.

"It's hard to imagine that Democrats or Republicans would vote to eliminate the charitable tax deduction," White House spokesman Jay Carney told reporters.

A much bigger prize is the money taxpayers shelter from taxes in 401(k) retirement plans offered by their employers. Experts estimate 80 percent of workers take advantage of the plans at companies where they're offered, each sheltering as much as $17,000 (it's going up to $17,500 shortly) annually from immediate taxation.

"The single most important factor in determining if a worker is saving for retirement is whether or not there is a plan at work," Brian Graff, executive director and chief executive officer of the Society of Pension Professionals & Actuaries, told Politico. "We understand Congress needs to reduce the debt and raise revenue but raiding the tax incentives for 401(k) plans will put American workers' retirement security at risk."

The Joint Committee on Taxation estimates eliminating the ability to shelter retirement savings from immediate taxation will cost the federal government $162.7 billion in 2014.

The benefit is far from safe. As long ago as 1986, tax code writers eyed it -- and that was just eight years after it became available. In his 2013 budget, President Obama proposed eliminating the shelter for those earning more than $250,000 a year.

Rep. Richard Neal, D-Mass., told Politico eliminating the deduction would be a mistake.

"I still prefer using the tax system to promote savings," Neal said. "I think there is substantial evidence -- whether it's the use of the 401(k) or the individual retirement account -- that it has worked."

And that brings us back to the "fiscal cliff" to which Washington is speeding.

Obama has offered a $4 trillion package: $1.6 trillion in new revenue -- $950 billion to be collected by allowing the Bush-era tax cuts to expire on incomes of more than $250,000, with the rest coming from the elimination or reduction of deductions and loopholes -- and $2.4 trillion in spending cuts. House Speaker John Boehner has offered a sentence: $800 billion in new revenue to come from closing loopholes and eliminating deductions, no specifics, spending reductions to come from entitlement reform.

Republicans rejected Obama's plan; the White House turned down Boehner's plan. But by the end of last week, Obama and Boehner were at least talking by phone, presumably discussing specifics.

White House spokesman Jay Carney -- and the president himself -- emphasized last week any deal will have to include a tax increase on the wealthy although Carney said Obama is not "wedded" to every aspect of his proposal.

But as former President Bill Clinton said, it all comes down to the numbers, arithmetic.

Jason Furman, principal deputy director of the National Economic Council, walked reporters last week through why just closing loopholes and eliminating deductions won't work by themselves.

"It's always a little bit like Jell-O," Furman said. "You look over here, the problem with this one; well, how about this one; the problem with that could fix this, and you go back to the first one."

Simply limiting deductions to $25,000 sounds good, but high-earners could hit that with just mortgage interest and property taxes alone, eliminating the incentive for charitable giving, Furman said. Plus, it would hit 17 million members of the middle class. So, scratch that.

"In the president's proposal you have the decoupling that gets you $950 [billion], and then he has an additional proposal where he takes the value of tax deductions and other tax expenditures and limits their value to 28 percent, which is what you'd get if you were upper-middle class -- in effect, you'd get 28 percent value for all of those," Furman said. "And so he trims them across the board and he saves several hundred billion dollars with that proposal."

Carney said a deal will be reached once "Republicans are ready to acknowledge that rates are going up... for top earners."

"If the Republicans believe that they have an alternative proposal that achieves the kind of revenue that's necessary, they ought to put it on paper," Carney said.

"And I think the reason they haven't is because they know, as Jason has just explained, that there isn't a plausible proposal that produces the amount of revenue necessary that could pass Congress or that makes economic sense."