Higher rates or fewer tax breaks _ what's worse?

Published on NewsOK Modified: December 7, 2012 at 8:31 am •  Published: December 7, 2012
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WASHINGTON (AP) — In the fiscal cliff wars, a pivotal battle is raging between Democrats demanding to raise revenue by boosting tax rates on the nation's highest earners and Republicans insisting on eliminating deductions and other tax breaks instead. Which is better for the economy? Analysts say it depends.

Economists generally agree that a simpler tax code with lower rates and fewer deductions, exemptions and credits would help the economy. With fewer tax preferences, people would be more likely to seek the best investments for their money instead of the most lucrative tax breaks. And lower rates would leave them more money to spend. Both would add oomph to the economy.

But ask whether the higher tax rates that President Barack Obama wants would hurt the economy more than curbing deductions, as Republicans assert, and the picture is less clear. While many economists say the economy theoretically would work more efficiently if the tax code provided fewer preferences, many said it would depend on which deductions lawmakers curb — a complicated exercise in a world where one person's wasteful loophole may be viewed by others as an economic lifeline.

For example, one of the biggest tax breaks is the widely popular deduction for interest on home mortgages below $1 million. Because of it, the government this year will take in $87 billion less than it would if the deduction didn't exist.

That deduction allows many to buy homes they otherwise couldn't afford and is strenuously defended by the housing industry. But critics say it does little to help lower-income people while it encourages others to go into debt for costlier homes than they need — an activity they say taxpayers should not subsidize.

"I'd definitely go for cutting deductions first, especially if I have the opportunity to make the choices about which deductions go," said Alan Auerbach, director of the Robert Burch Center for Tax Policy and Public Finance at the University of California, Berkeley.

The clash is a key part of negotiations for a deal to avert big tax increases and spending cuts due to begin in January — the fiscal cliff — unless Obama and Congress reach an accord on some other way to rein in the government's ballooning debt.

Obama wants to raise $1.6 trillion in revenue over the next 10 years, partly by letting decade-old tax cuts on the country's highest earners expire at the end of the year.

He would continue those Bush-era tax cuts for everyone except individuals earning more than $200,000 and couples making above $250,000. The highest rates on top-paid Americans would rise from 33 percent and 35 percent today to 36 percent and 39.6 percent.

House Speaker John Boehner, R-Ohio, has offered $800 billion in new revenues to be raised by reducing or eliminating unspecified tax breaks on upper-income people.

There are more than 100 tax breaks with a cumulative price tag estimated at $1.1 trillion yearly. They range from huge breaks like the deduction for charitable contributions and the income exclusion for employer-provided health insurance to obscure tax incentives for capturing carbon dioxide emissions or maintaining railroad tracks.

The nonpartisan Congressional Budget Office said in a report last month that raising tax rates would dampen people's incentive to work and reduce the nation's labor supply. Raising the same amount of revenue by eliminating tax breaks would probably be less negative, but the impact would depend on which deductions were erased, the budget office said.

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