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 on Tuesday called for scrapping a venerated U .S. tax r eform model in re marks t hat hardened his party's negotiating position ah ead of talks set to gain momentum soon on the so -called "fiscal cliff".

Senator Charles Schumer , i n what Republicans saw as tax- po licy blasphemy, declared President Ronald Reagan's 1986 tax reform "obsolete" as a model fo r ov erhauling 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 to deficit reduction instead, and advocated raising t ax rates o n the rich i n any deal to avoi d the fiscal cliff a pproaching 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.

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, 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.

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

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

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

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.

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