Partisan reality check on tax reform

@CNNMoney June 20, 2012: 5:13 PM ET
A Democratic paper aims to show Republicans would hurt the middle class. But their analysis really contains lessons for both parties on the hard truths about tax reform.

A Democratic paper aims to show Republicans would hurt the middle class. But their analysis really contains lessons for both parties on the hard truths about tax reform.

NEW YORK (CNNMoney) -- An analysis from Senate Democrats released Wednesday found that many in the middle class could pay more under a House Republican tax reform proposal than they do today, while the uber-rich would pay less.

The analysis -- while partisan -- highlights a hard truth that both parties skate over when discussing the glories of tax reform: Lower rates will come at a cost. And someone will have to pay.

House Republicans have proposed reducing the number of income tax rates to just two: 10% and 25%. They also want to eliminate the Alternative Minimum Tax. (Quiz: What the rich really pay in taxes)

To help make up for trillions of dollars in lost revenue, Republicans would "broaden the base" -- meaning they would close tax loopholes and get rid of or reduce other breaks in the code.

They don't, however, specify which ones.

The Democrats' analysis assumes five major tax breaks would be eliminated: the deductions for mortgage interest, state and local income tax and charitable contributions, as well as tax breaks on 401(k) contributions and employer-provided health care.

Those five tax breaks disproportionately benefit the upper middle class. Part of the reason the rich do so well in the Democratic analysis is the loss of those five tax breaks would not override the tax savings they would receive if the top rate were lowered to 25%, said Roberton Williams, senior fellow at the independent Tax Policy Center.

The only way to level the playing field would be to also scale back the breaks that disproportionately benefit the rich -- such as lower tax rates on investment income and tax-exempt income such as that from municipal bonds.

"If we don't cut the preferences that help the rich, they will benefit greatly from the reduction in rates at the expense of everyone else," Williams said.

The Democratic analysis also inadvertently points out another huge challenge facing tax reformers.

There are hundreds of tax breaks on the books. But if lawmakers want to lower rates a lot, they'll have to attack the biggest five or six breaks -- which also happen to be the most popular. Otherwise, they won't get very far in terms of making up for lost revenue.

That means the middle class very likely will see some of their cherished tax breaks curtailed, if not eliminated.

A good example is a tax reform plan from a bipartisan deficit reduction task force led by former Congressional Budget Office Director Alice Rivlin and former Sen. Pete Domenici.

It also proposed having just two income tax rates: 15% and 28%.

But to pay for those lower rates and raise revenue to help with deficit reduction, they made a host of changes to tax breaks that would affect both the rich and the middle class.

The Rivlin-Domenici plan would tax capital gains and dividends as ordinary income; eliminate the deduction for state and local taxes; convert the mortgage deduction to a 15% credit on interest up to $25,000 a year; and limit the tax break on retirement savings contributions.

It may be tempting to think only the rich should bear the burden of base broadening. But, Williams noted that "[while] the rich may have a lot of money ... they're not bottomless pits." To top of page

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