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UPDATE 2-Reagan tax reform "obsolete" in fiscal cliff talks-Schumer

(Adds Clint Stretch comment, background)

By Kim Dixon

WASHINGTON, Oct 9 (Reuters) - A top Senate Democrat onTuesday called for scrapping a venerated U .S. tax r eform modelin re marks t hat hardened his party's negotiating position ah eadof talks set to gain momentum soon on the so -called "fiscalcliff".

Senator Charles Schumer , i n what Republicans saw astax- po licy blasphemy, declared President Ronald Reagan's 1986tax reform "obsolete" as a model fo r ov erhauling tax laws.

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

Schumer urged devoting new revenues to deficit reductioninstead, and advocated raising t ax rates o n the rich i n any dealto avoi d the fiscal cliff a pproaching at year-end.

"Tax reform 25 years ago was revenue-neutral. It did notstrive 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 fromclosing loopholes and put them into reducing rates for thehighest income brackets, rather than into reducing the deficit."

Two Democratic Senate aides said the speech was an attemptby 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.

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

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

In addition, $100 billion in automatic federal spendingcuts will take effect unless Congress acts. Combined, theseevents could push the economy into a recession, studies haveforecast.

Decisions on the "fiscal cliff" will be strongly influencedby the outcome of the elections, of course, and will be aproving ground for Congress' ability to tackle a potentiallymore fundamental tax code overhaul, perhaps in 2013.

The tax code has not been overhauled thoroughly in 26 yearssince Reagan and a divided Congress managed to do it. Eversince, 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 talkson the fiscal cliff, we ought to scrap it," Schumer said.

If applied today, revenue neutrality would inevitably hurtthe middle-class by forcing curtailment of tax breaks, he said.

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

Schumer is right to caution th at middle class tax breaksma y be in jeopardy, said Clint Stretch, a former congressionalstaffer on budget issues a nd former top tax lobbyist.

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

Both Obama and Romney say the tax code needs a majoroverhaul, but their approaches differ markedly.

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

(Reporting by Kim Dixon; Editing by Theodore d'Afflisio)

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

Keywords: USA CONGRESS/TAXES