Deficit panel recalibrates, seeks more support

Senate staff members pick up copies of U.S. President Barack Obama's 2011 Budget as it is distributed on Capitol Hill in Washington February 1, 2010.

WASHINGTON (Reuters) - A presidential commission trying to balance the U.S. budget on Wednesday softened a proposed tax overhaul to win broader support for its bold plan to slash the $1.3 trillion federal deficit.

The plan faced an uphill struggle to win sufficient backing to trigger a congressional vote. Even if that happens, analysts predict Congress won't take substantive steps to reduce the deficit this year.

Changes made to the plan included dropping a proposal to kill the popular mortgage interest tax deduction, as had been recommended on November 10. The revised version proposed a limited, 12 percent mortgage interest tax credit.

In an attempt to attract backing from elected lawmakers on the 18-member commission, the revised plan also backed off a proposal to tax capital gains and dividends as ordinary income and suggested a 20 percent investment income exclusion.

Two key senators -- Democrat Kent Conrad and Republican Judd Gregg -- said they would support the plan at a meeting on Wednesday. A final commission vote is set for Friday.

The panel's co-chairmen need 14 "yes" votes to trigger a congressional vote on the proposal. President Barack Obama set up the commission in February.

The panel's revised plan envisages reducing the budget deficit to 2.3 percent of gross domestic product by 2015, from 8.9 percent in the last fiscal year -- a figure bloated by efforts to lift the U.S. economy out of its deepest recession since the 1930s, Bush-era tax cuts and two costly wars.

To accomplish that goal, the plan urges deep cuts in military and domestic programs starting in 2012, a 15 cent per gallon hike in the gas tax and requiring Medicare participants to pay more costs themselves. It also recommends raising the age for receiving Social Security benefits.

SEVEN VOTES FOR PLAN

At Wednesday's meeting, seven commission members, including co-chairmen Erskine Bowles and Alan Simpson, expressed support for the plan; one member voiced opposition; and the remainder expressed concerns without committing one way or the other.

Bowles was chief of staff for former Democratic President Bill Clinton. Simpson is a former Republican senator.

Bowles vowed not to retreat from the hardest-hitting aspects of the plan, a result of months of debate. "Al and I are not going to wimp out. For us, it's go big or go home ... We're not interested in 14 votes for a whitewash," Bowles said.

Democratic Representative Jan Schakowsky, a commission member, said "I can't support it and will be voting no."

Republican Representative Paul Ryan said: "I don't believe this sufficiently fixes the healthcare problem."

AARP, which represents millions of older Americans, said the plan would cut Social Security too deeply and raise Medicare costs for beneficiaries.

"The latest report on deficit reduction would actually increase the health and economic insecurity of millions of Americans," AARP Executive Vice President John Rother said.

The commission's work came to a head amid an escalating debt crisis in Europe that offered a reminder of the value of fiscal restraint. But fears that the contagion could spread has driven investors into U.S. Treasury bonds, holding down the government's borrowing costs.

A fierce debate also was under way on Capitol Hill over Bush-era tax cuts that played a key role in boosting the deficit close to levels not seen since World War Two.

Extending the Bush tax cuts would drive the deficit higher. Obama has argued for letting them lapse for families earning more than $250,000 a year. Republicans, who take control of the House of Representatives in January after November's Democratic election defeats, say any lapse would harm the economy.

PLAN CUTS DEFICIT

As in the draft, which was widely criticized, the commission's revised plan calls for lower corporate tax rates and targets $4 trillion in deficit reduction through 2020.

It freezes 2012 discretionary spending at 2011 levels and returns it to pre-crisis 2008 levels in 2013, while capping its growth beyond 2013 at half the projected inflation rate.

In a largely symbolic gesture, it recommends cutting the budgets of the White House and Congress by 15 percent and immediately freezing the salaries of members of Congress, along with a three-year freeze on non-military federal worker pay and a reduction of 200,000 jobs from the federal workforce.

Instead of ending the charitable gift tax deduction, as the draft proposed, the revision calls for a 12 percent credit.

The revision also calls for a payroll tax holiday of $50 billion to $100 billion in 2011; reducing the number of income tax brackets to three from six; eliminating congressional budget earmarks; and creating new budget categories for overseas military operations and disaster relief.

(Additional reporting by Andy Sullivan, Alister Bull and Kim Dixon; Editing by Stacey Joyce)