Congressional negotiators, trying to avert a fiscal crisis in January, are examining ideas that would allow effective tax rates to rise for the wealthy without technically raising the top tax rate of 35 percent. They hope the proposals will advance negotiations by allowing both parties to claim they stood their ground.
One possible change would tax the entire salary earned by those making more than a certain level — $400,000 or so — at the top rate of 35 percent rather than allowing them to pay lower rates before they reach the target, as is the standard formula. That plan would allow to say they did not back down in their opposition to raising marginal tax rates and Democrats to say they prevailed by increasing effective tax rates on the rich. At the same time, it would provide an initial effort to reduce the deficit, which the negotiators call a down payment, as Congressional tax-writing committees hash out a broad overhaul of the tax code.
That idea could be combined with the reinstatement of tax code provisions that once prevented the rich from taking personal exemptions or itemizing deductions. Those rules were eliminated by the tax cut of 2001. Reinstating them would tack an additional one to two percentage points onto the effective tax rates of high-income households without raising the 35 percent rate, but which households would be affected has not been decided. In all, tax experts say, families in the top tax bracket would find their effective tax rate jump to 41 percent, even though the top statutory rate would remain 35 percent.
The proposals have been floated as a way to speed up negotiations to avert a crisis in January when the tax cuts passed under President George W. Bush expire and across-the-board spending cuts on military and domestic programs automatically kick in. This "fiscal cliff" would squeeze hundreds of billions of dollars out of the fragile economy next year and, many economists say, send the country back into recession.
President Obama met a week ago with House Speaker John A. Boehner of Ohio; Representative Nancy Pelosi of California, the House minority leader; Senator Harry Reid of Nevada, the majority leader; and Mitch McConnell of Kentucky, the leader of the Senate Republicans, and both parties emerged confident a deal could be struck.
Since then, progress has slowed considerably. The Congressional leaders had said that aides would provide concrete ideas by Wednesday on deficit reduction targets through revenue increases and changes to social programs, especially Medicare. White House and Congressional staff members did meet early this week, but no such ideas were produced. Democrats want Republicans to first define what they mean by "structural changes" to Medicare and Medicaid. Republicans say Mr. Obama should make the first move, using what they say is the political capital gained by his re-election.
But aides involved in the negotiations said they remained confident, in part because many of the ideas that could break the impasse were fleshed out during successive but fruitless deficit negotiations between the president and Mr. Boehner and between Vice President Joseph R. Biden Jr. and Representative Eric Cantor of Virginia, the House majority leader, and during the deliberations of the Congressional "supercommittee" on deficit reduction formed during the 2011 impasse over raising the nation's borrowing limit. One Republican aide involved in the current talks said both sides believe a deal can be reached before Christmas.
The supercommittee drafted a proposal that would have eliminated tax brackets lower than 35 percent for affluent families, taxing the first dollar of taxable earnings at the highest tax bracket. In the late 1980s, the tax code included a similar rule, which "clawed back" savings from lower tax rates for some rich families.
Under the existing tax code, the first $17,400 of adjusted gross income for a couple filing jointly is taxed at 10 percent. Above that level, up to $70,700, income is taxed at 15 percent. Income between $70,701 and $142,700 is taxed at 25 percent. Gross incomes up to $217,450 are taxed at 28 percent. The next bracket, 33 percent, ends at $388,350 for couples. The top bracket hits adjusted gross incomes only above $388,350.
All taxpayers get the advantage of the lower tax rates below the top threshold, whether they earn $40,000 or $40 million.
If Republicans insist that the top 35 percent rate cannot change while Congress tries to rewrite the tax code, negotiators could decide to technically keep all the Bush-era tax rates in place, but eliminate the lower tax rates for rich households.
"Would you consider that a tax rate increase?" asked one aide familiar with the idea. "It would not impact the top marginal rate, and no one would have an effective rate over 35 percent." But, he added, taxes would rise for the rich. He, like other aides, spoke on condition of anonymity because Congressional leaders want negotiations to be kept quiet.
A Democrat familiar with the proposal called it plausible, but said its future would depend on an official scoring of how much revenue it would raise. White House and Congressional aides "are looking at lots of creative options," the Democrat said.
Negotiators have at least agreed on the shape of a deal. They would establish a framework that would stipulate fixed amounts of revenues to be raised through rewriting the tax code and through savings to be generated by changes to social programs and other federal programs like farm subsidies. The negotiators also want to propose additional cuts in programs included in annual Congressional spending bills, although Democrats want to hold further cuts to a minimum, arguing they agreed to $1 trillion in domestic discretionary cuts over 10 years in last year's Budget Control Act without a dime in tax increases.
It would be up to Congressional committees next year to draft the legislation to meet those targets, but Congress would be given special instructions to ease passage of the bills.
Once the target numbers are settled, negotiators would have to come up with a down payment on deficit reduction to show the world's financial markets that Washington is serious. That is where the creative tax ideas would come in. The negotiators would also have to agree on a fallback plan that would ensure the deficit would be cut even if Congress failed to approve tax and entitlement overhauls.
The down payment and the fallback are sticking points. Democrats want a large down payment, financed immediately by higher taxes on the rich, preferably by simply letting the top two income tax rates from the Bush era expire. Republicans say the down payment can be minimal.
Arguments over the fallback reflect a philosophical divide. Many Democrats want it to be so onerous that Congress would see no choice but to act on more sensible plans. Some argue that after six months the current looming crisis would simply reappear. Some Republicans say the fallback plan should itself be an acceptable alternative.