In Republicans' push for tax overhaul, popular deductions on the block
* Cutting tax breaks weighed to offset lower top tax rate
* Backers might seek to reduce top rate to 25 percent
* Mortgage interest and 401(k) deductions eyed
By Donna Smith
WASHINGTON, May 14 (Reuters) - It has been nearly 20 years since President George H.W. Bush lost his bid for re-election after making a "no new taxes" pledge, and then agreeing to raise taxes. Since then, Republicans have not touched hundreds of tax breaks in U.S. tax laws, fearing that doing so could be called a tax hike.
That could be changing.
They're not advertising it, but Republicans in Congress, along with a few Democrats, are exploring the idea of limiting or ending some of Americans' most sacred tax breaks. They include deductions on contributions to 401(k) retirement accounts and possibly those on home mortgage interest, each of which save millions of Americans thousands of dollars each year.
As was the case nearly six months ago when a bipartisan congressional "super committee" couldn't agree on how to trim more than $1 trillion from the federal deficit, the Republicans are doing so with a bigger goal in mind.
They want to limit the deductions to help pay for their plan to lower the top federal tax rate from 35 percent - most likely to the 25 percent called for in the House Republican budget plan crafted by Wisconsin Representative Paul Ryan, and endorsed by presumed Republican presidential nominee Mitt Romney.
"It's a full review of the tax code, including all of the credits, deductions, exemptions and loopholes," said a senior House Republican aide who is not authorized to comment publicly. Tax writers are warning colleagues that although not every tax break has to go in order to lower rates, "you have to touch a lot of things," the aide said.
It all would be part of a Republican strategy to lower overall tax rates while getting some of the roughly 45 percent of Americans who now pay no income taxes to start paying. Most of those people aren't required to pay because they are poor, or are able to claim enough deductions to eliminate their tax bills.
Such a scenario is a non-starter to most Democrats, including those who control the Senate.
Democratic leaders say that although it's unclear precisely how such a plan would affect each taxpayer, it almost certainly would unfairly squeeze the middle class, have little impact on reducing a federal debt expected to top $16 trillion this year, and become a giveaway to the wealthy.
Even so, House Republicans are vowing to shape the budget debate by pressing ahead with their version of tax reform.
They're hoping that the Nov. 6 elections will help put their budget plans in play by putting Romney in the White House, maintaining their majority in the House and perhaps giving them control of the Senate.
For Republicans seeking the most significant overhaul of the U.S. tax code since 1986, Ryan's budget plan has brought on a sense of urgency in part because it does not identify how to pay for what analysts say would amount to more than $4 trillion in tax revenue that would be eliminated over the next decade.
That doesn't include the multibillion-dollar budget hole that would be created if Republicans succeed in extending Bush-era tax cuts that are scheduled to expire at the end of the year.
With those numbers in mind, House Ways and Means Chairman Dave Camp of Michigan has been talking with fellow Republicans and Democrats about which long-term tax breaks could be cut back or killed.
The list of money-saving deductions that could be targeted to try to make Ryan's budget work is long.
Among the deductions that Camp's committee is examining are those that Americans enjoy for contributions to 401(k) and other retirement savings accounts. For 2012, tax-free contributions to 401(k) plans are limited to $17,000 (or $22,500 for those age 50 and older), but withdrawals are taxed.
Tax breaks for retirement savings cost the federal treasury nearly $84 billion a year, according to the Congressional Research Service.
Camp said that early estimates of the cost of lowering the overall tax rate to 25 percent suggest that "you don't have to eliminate all deductions" to make it work. "You will be able to keep some" deductions.
Between now and the Nov. 6 election, "we'll see a lot of brave talk" about going after popular deductions and trimming tax rates, said Steve Bell, a former senior Senate Budget Committee Republican staff member who is now with the Bipartisan Policy Center. "But I expect nothing in specifics" before the election.
Republicans' move to rewrite the U.S. tax code is likely to cause divisions within the Republican Party, where conservative Tea Party activists see spending cuts and shrinking the government bureaucracy - rather than revenue-raising measures that could lower families' after-tax income - as the ways to deal with mounting deficits.
There appears to be growing flexibility among some Republicans as the government's dire financial situation becomes clearer.
Even influential anti-tax activist Grover Norquist - whose Americans for Tax Reform has gotten the vast majority of Republicans in Congress to agree to oppose tax increases or limits on deductions that would cost taxpayers - has said he would accept the idea of reduced deductions in exchange for lower tax rates.
"Some people are willing to allow revenues to go a little higher if the (tax) rates come down, some people are not willing to let the revenues go higher, some people are willing but not saying it," said Alex Brill, a former senior Republican staff member of the tax-writing House Ways and Means Committee who now is with the American Enterprise Institute think tank.
Among the tax breaks that are designed to encourage economic activity the mortgage interest deduction is one of the biggest, amounting to about $388 billion in deductions for taxpayers last year. Most lawmakers are reluctant to do away with it, but some are toying with the idea of limiting it.
In politics, the mortgage deduction is a hyper-sensitive issue.
That was evident last month, after Romney told a group of supporters that he might support ending or limiting the mortgage interest deduction on second homes for high-income earners, and likely would support doing the same for state income and property tax deductions.
Romney's suggestion would not affect most homeowners, and it would raise only about $13 billion over 10 years, according to Congress' Joint Committee on Taxation.
However, his comments sparked an outcry from the National Association of Realtors, whose chief economist, Lawrence Yun, said it would send a "terrible signal" to potential home purchasers that more limits to the home mortgage interest deduction were coming.
The Realtors group says that eliminating mortgage deductions of any type could have a broad impact on the U.S. economy by lowering home values and hurting the housing market just as it is emerging from the 2007-2009 financial crisis and a wave of foreclosures.
The group said it expects thousands of members to rally at the Washington Monument on Thursday to call on Congress to "protect the American Dream" by preserving deductions for mortgages.
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