UPDATE 4-Defense cuts spat clouds US deficit panel debate

Thu Sep 8, 2011 6:54pm EDT

* Sen. Kyl rejects any further defense spending cuts

* Some Republicans suggest broad tax reforms

* Democrats say job creation is key (New throughout)

By Richard Cowan and Kevin Drawbaugh

WASHINGTON, Sept 8 (Reuters) - On the first day of work on Thursday for a "super committee" charged with finding $1.2 trillion in new government savings, a member of the panel threatened to quit if defense spending cuts are discussed, underscoring the difficulties ahead.

Despite Republican Senator Jon Kyl's surprise disclosure after the panel's inaugural meeting that "I'm off of the committee if we're going to talk about further defense spending," other Republicans worked to put comprehensive tax reform squarely on the agenda and urged bipartisanship.

A broad revamp of the U.S. tax code, which hasn't been done in 25 years since the Reagan administration, could include lowering corporate tax rates, eliminating special-interest tax breaks and raising taxes on the wealthy.

Besides streamlining tax law, lawmakers hope it will help boost revenues, encourage corporate investment and create new jobs.

Kyl's threat overshadowed the tax initiatives and came as many lawmakers were hoping to put their bickering aside, having attacked each other all year over budget priorities amid annual deficits topping $1 trillion.

Democratic Senator Patty Murray, a co-chair of the super committee, applauded her colleagues' early show of bipartisanship, saying, "Committee members have refrained from drawing lines in the sand or carving out areas that can't be touched."

That quickly changed when Kyl, speaking to some conservative think tanks immediately following the panel's hour-long meeting, said he wouldn't tolerate any more cuts to defense. It was reminiscent of Republican demands in earlier budget talks that tax increases be off the table.

U.S. spending on security programs, including defense, was cut by $350 billion as part of a $917-billion deficit-reduction plan enacted last month. But Republicans were devising ways for the Pentagon to escape much of those cuts with diplomatic and foreign aid programs shouldering most of the pain.

TACKLING TAX REFORM

The 12 congressional Democrats and Republicans serving on the super committee have until Nov. 23 to forge a deficit-reduction deal that a majority can support.

If they fail, about $1.2 trillion in spending cuts over 10 years, divided equally between domestic and defense programs, would automatically begin in 2013.

Democrats say they want a "balanced" package of spending cuts and tax increases, while Republicans want to tackle the fast-rising costs of popular benefit programs such as Medicare and Medicaid healthcare for the elderly and poor and the Social Security retirement program.

One way to address both could be to revamp the U.S. tax code, which is widely seen as too complicated and riddled with loopholes. With broad tax reform, lawmakers might be emboldened to also rein in benefit programs.

"Comprehensive tax reform would spur economic growth and job creation and should be part of our discussions," said Republican Representative Dave Camp, who also chairs the tax-writing House Ways and Means Committee.

But Camp's Senate counterpart, Finance Committee Chairman Max Baucus, a Democratic member of the super committee, injected a political reality.

While he agreed that the panel should look at broad tax reform, he noted the super committee's "short period (for working out a deficit deal) just makes it difficult."

David Kendall, senior fellow with the centrist think tank Third Way, said Thursday's developments underscored that "The two hot issues for Republicans are defense cuts and tax reform."

He added, "They're trying ... to get control of the debate" by crowding out Democrats' hopes for some targeted tax hikes and replacing them with debate about broad tax reform.

Many congressional aides confide, however, that rewriting the tax code in the next 10 weeks is virtually impossible.

Republicans on the super committee also could feel vulnerable to attacks from conservative Tea Party activists if they end up embracing more defense cuts in a new budget deal.

As union-backed protesters chanted for jobs and briefly interrupted the super committee's meeting, Democrats on the panel said deliberations should not focus on deficit-reduction at any cost.

Representative James Clyburn, a liberal Democrat, said that "Debt and deficit reduction should be intertwined into a strong code of job creation, budget cuts and tax reform." (Additional reporting by Donna Smith, David Alexander and Thomas Ferraro; editing by Anthony Boadle)

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