Why President Obama insists on raising tax rates

One of the most puzzling aspects of the “fiscal cliff” negotiations, at least to me, has been President Obama’s insistence on raising the tax rates on the highest income brackets. After appearing flexible on that issue in the days after the election, he has since made it abundantly clear that any deal with the GOP must increase the government’s bite on individual incomes greater than $200,000 and on couples earning more than $250,000.

Why raise marginal rates when there are other approaches that could generate the same amount of revenue without distorting labor and investment incentives or making the United States less attractive to global entrepreneurs? For example, capping deductions at $25,000 for upper-income households would raise almost as much money as ending the Bush-era tax breaks for those groups, according to a new report from the Committee for a Responsible Federal Budget.

Some Republicans, such as former White House advisor David Gergen, argue that Democrats want to embarrass Republicans by forcing them to break their pledge not to raise taxes. There may be an element of truth to that, but that’s not likely to be a big factor in Obama’s stance. After all, the president argues that voters are the ones who chose a “balanced” approach -- that is, a combination of spending cuts and tax increases -- to fixing Washington’s fiscal woes. They did so by electing him instead of Republican Mitt Romney, whose main campaign pledge was to cut tax rates.

A more likely explanation is that Obama simply doesn’t believe any other revenue raiser will work as well as higher tax rates. He made this case Wednesday in remarks to the Business Roundtable, a group of influential corporate chief executives. After saying he had no objection to simplifying the tax code and eliminating some exemptions, deductions and credits, he said such an approach couldn’t generate the kind of revenue that raising the top marginal rates can.

Oh sure, Obama said, it can be done on paper. But it can’t be done on Capitol Hill.

“In order for us to raise the amount of revenue that’s needed just by closing deductions and loopholes for high earners, we’d have to, for example, eliminate or severely cap the charitable deduction,” Obama said. “And folks in this room, you guys are not only CEOs -- I can’t imagine there’s a person here who doesn’t sit on a number of non-for-profit boards, university boards, hospital boards. In your respective communities, you are supporting an entire infrastructure that is the glue that holds our communities together. So the notion that somehow we’re going to just eliminate charitable deductions is unlikely.

“What that means is, is that any formula that says we can’t increase tax rates probably only yields about $300 to $400 billion, realistically. And that’s well short of the amount of revenue that’s needed for a balanced package,” he said.

His own proposal calls for about $1.6 trillion in additional revenue over the coming decade, about half of it coming from raising the marginal rates on the top 2% of U.S. incomes.

He’s right that it would be a huge challenge politically to end the tax deduction for charitable giving. The same could be said for other costly breaks, such as the deduction for home mortgage interest and the exemption for employee health benefits. The constituencies for those preferences are just too powerful.

But that’s the beauty of a cap on deductions, credits and exemptions, as outlined by the Committee for a Responsible Federal Budget. Congress wouldn’t have to try to eliminate any of the tax code’s sacred cows. Instead, it would be up to taxpayers to decide which, if any, to cut back on after the cap took effect.

Changing the tax code is tricky business, so it makes little sense to try to rush it through Congress in the final weeks of the year. Both sides recognize that, and are trying just to agree on a framework now and leave the details for next year. Ideally, Obama and GOP leaders would agree to an amount of revenue to be raised over the coming decade without settling on how. That would leave open the possibility of finding an alternative to higher rates, if it met the same revenue target.

The president keeps saying that he’s open to new ideas. It may be that his insistence on higher rates is simply a negotiating tactic to prod Republicans -- who’ve proposed to increase revenue by $800 billion -- to accept a higher number. But it’s also possible that Democrats have become so wedded to ending the Bush-era tax cuts for top earners, Obama can’t drop that demand without appearing to have conceded too much. For the sake of reaching a deal, let’s hope not.

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