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UPDATE 3-Reagan tax model obsolete in fiscal cliff talks-Schumer

(Adds Gang of Eight details, presidential positions)

By Kim Dixon

WASHINGTON, Oct 9 (Reuters) - A top Senate Democrat on Tuesday said new tax revenues should go to reducing the federal deficit, not cutting tax rates, dismissing as "obsolete" a Reagan-era model of tax reform.

Senator Charles Schumer, hardening his party's negotiating position ahead of talks on the so-called "fiscal cliff," declared President Ronald Reagan's 1986 tax reform an unaffordable model for overhauling the tax laws.

U.S. tax policy experts have long advocated Reagan's approach of "revenue neutrality," or using new government revenues from closing tax loopholes to pay for tax rate cuts.

Schumer urged devoting new revenues wholly to deficit reduction instead, and advocated raising tax rates on the rich in any deal to avoid the fiscal cliff approaching at year-end.

"Tax reform 25 years ago was revenue-neutral. It did not strive to cut the debt. Today, we can't afford for it not to," Schumer said in a speech at the National Press Club.

"It would be a huge mistake to take the dollars we gain from closing loopholes and put them into reducing rates for the highest income brackets, rather than into reducing the deficit."

Two Democratic Senate aides said the speech was an attempt by Democrats to harden their position ahead of "fiscal cliff" negotiations set to get under way after the Nov. 6 elections.

Republican Senator Orrin Hatch blasted Schumer's comments, and criticized Democrats, saying in a statement that their "default position" is to raise taxes.

'CLIFF' AHEAD

At the end of the year, several urgent fiscal issues will converge, including the expiration of lowered individual income tax rates enacted a decade ago under President George W. Bush.

The Bush tax cuts were due to expire at the end of 2010, but Obama and Congress agreed to extend them for two years to prevent damage to the economy.

In addition, $100 billion in automatic federal spending cuts will take effect unless Congress acts. Combined, these events could push the economy into a recession, studies have forecast.

Decisions on the "fiscal cliff" will be strongly influenced by the outcome of the elections, of course, and will be a proving ground for Congress' ability to tackle a potentially more fundamental tax code overhaul, perhaps in 2013.

The tax code has not been overhauled thoroughly in 26 years since Reagan and a divided Congress managed to do it. Ever since, the Reagan reforms have been seen as a model, with "revenue neutrality" being their central feature.

Schumer said that model is outdated. "In the upcoming talks on the fiscal cliff, we ought to scrap it," Schumer said.

If applied today, revenue neutrality would inevitably hurt the middle-class by forcing curtailment of tax breaks dear to average Americans, he said.

"A 1986-style approach that promises upfront rate cuts to the wealthy is almost guaranteed to give middle-income earners the short end of the stick," said Schumer, the third most senior Democrat in the Senate.

OVERHAUL NEEDED

Both President Barack Obama and Republican challenger Mitt Romney say taxes need an overhaul, but disagree on details.

Obama backs raising individual income tax rates on the wealthy by letting their Bush tax cuts expire, but extending the Bush tax cuts for the middle class. He has also presented a detailed plan on corporate tax breaks he wants to kill.

The president also wants to raise the tax rates on dividends and on capital gains for the two highest income tax brackets.

Neither Obama nor Romney has presented specifics on what to do with the costliest tax breaks such as the mortgage interest and charitable donation deductions, although both have discussed the possibility of capping deductions at some level.

Romney has called for a 20 percent across the board cut in all tax rates, as well as eliminating the estate tax and the alternative minimum tax - changes that would help the wealthy.

But Romney has also said he will not reduce the share of taxes paid by the wealthy. He has said he will pay for his tax cuts by ending tax breaks, but he has not said which ones.

BIPARTISAN APPROACH?

Clint Stretch, a former congressional staffer on budget issues and former top tax lobbyist, says Schumer is right to caution that middle class tax breaks may be in jeopardy.

"If you don't raise taxes you'll have to get rid of a lot of federal programs very important to the middle class," he said.

Schumer said he backs efforts by a bipartisan group of senators known as the "Gang of Eight." This group met again on Tuesday to discuss a possible deal on the deficit. Such meetings have been going on for years, with no solid results, aides said.

The group of four Democrats and four Republicans ranges from liberals to some of the most fiscally conservative lawmakers.

Operating outside of the formal tax-writing committees and party leadership, the lawmakers have been trying to forge a broad deficit-cutting plan that could include new revenue, a prospect that many in the Republican party adamantly oppose.

(Editing by Theodore d'Afflisio, Kevin Drawbaugh and Tim Dobbyn)

((Kim.Dixon@thomsonreuters.com)(202-281-9321))

Keywords: USA CONGRESS/TAXES