Watch out, middle class Americans.
President Obama wants to tie spending cuts to tax revenue hikes in the debt ceiling talks, but that could mean trouble for the middle class taxpayers he has pledged to protect.
"They'll have to go down to where the real money is, which is the middle class," said Brian Gardner, Washington policy analyst with Keefe, Bruyette & Woods, an investment bank. "Politically, that would be very tough."
The White House and Congress just finished a bruising fiscal cliff battle that raises taxes on the rich by $618 billion over a decade. Next up is the debt ceiling debate and dealing with the sequester -- automatic spending cuts set to kick in by early March.
Republicans want any debt limit increases to be coupled with spending cuts. In return, Democrats are demanding more revenue, mentioning closing loopholes and corporate subsidies like the $38 billion given to the oil industry over 10 years.
But to bring in significant tax revenues, lawmakers would have to tap into some politically sensitive tax deductions, said Robert Bixby, executive director of the Concord Coalition.
"The problem with exempting the middle class from any pain is that it's hard to make the numbers work," Bixby said. "Corporate tax loopholes are not as large as the ones for individuals."
How to raise a trillion dollars
Tax exclusions and deductions total roughly $1.1 trillion a year, but less than 10% benefit corporations, according to the Tax Policy Center. That means most cuts to those benefits would hit individuals.
So who would pay? Further restricting itemized deductions and exclusions for the rich could be one way to bring in several hundred billion dollars over a decade, but there may not be enough there to raise enough revenue to balance out the spending cuts.
Eliminating several other major tax breaks could also bring in billions a year in savings for the government, but would amount to tax increases on the middle class people that benefit from them.
For example, the largest exclusion is the one for employer health insurance, which totals $164 billion for fiscal 2014, according to the Congressional Research Service. This one spares the 60% of Americans who have employer-sponsored coverage from paying taxes on the share of health insurance premiums paid for by their companies. Without the tax break, companies might offer less generous plans.
Another tax break that helps the middle class save for retirement is the one for employer-provided pensions, which allow companies to offer tax-deferred pensions and 401(k)s. But at a cost of nearly $163 billion in revenue, this one could also be a major target for savings.
And one of the most cherished middle-class tax breaks -- the mortgage interest deduction -- costs nearly $100 billion a year. Nearly 40% of filers claiming this deduction make between $50,000 and $100,000 a year.
But major reform of any kind still faces many obstacles. The Democrats won't have a lot of leverage to negotiate any tax increases going forward, experts said. The Republicans were more willing to bend during the fiscal cliff negotiations because they were facing a massive tax hike on everyone had the Bush tax cuts expired. Now, there's no such threat.
"The incentive to support major tax reform is gone," said George Yin, a law professor at the University of Virginia and former chief of staff at Congress' Joint Committee on Taxation.