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Analysis: Debt talks producing only tax symbolism so far

Jul 7, 2011, 1:08 p.m.

By Kevin Drawbaugh

WASHINGTON (Reuters) - Symbolic gestures and possible agreements in principle, but not substantive reform, are likely to be the main tax policy result of urgent talks about raising the U.S. debt ceiling.

As President Barack Obama and congressional leaders met on Thursday, there was talk of ending ethanol subsidies and tax loopholes for corporate jets, private equity financiers and Big Oil.

While such steps would be important political signposts, they would barely move the needle on cutting the $1.4 trillion U.S. budget deficit and $14.3 trillion national debt.

A broad overhaul of the tax code, like the one proposed in December by Obama's Simpson-Bowles deficit commission, would be needed for that. But it would take much more time to complete than the debt ceiling negotiators are now dealing with.

Only 27 days are left to raise the debt limit and prevent the government from defaulting on its borrowings for the first time in U.S. history, an event that could devastate world markets.

A comprehensive tax overhaul could take months or longer. President Ronald Reagan and congressional Democrats needed two years to get the last major one to the finish line in 1986.

"We haven't even started the car yet, let alone get it out of the garage," said a top congressional aide on the tax reform project, which most aides and analysts expect will have to wait until late 2012 and into 2013, after presidential and congressional elections in November next year.

The Obama administration is drafting a proposal for tax code changes expected to be released later this year.

Taxing private equity fund managers' gains as ordinary income, instead of as capital gains, as is now done, would raise $2.2 billion in 2012, or $21.4 billion from 2012 to 2021, according to Congress' Joint Committee on Taxation.

TAX BREAKS AND LOOPHOLES

Ending two oil and gas industry tax breaks -- last-in, first-out inventory accounting and expensing of exploration and development costs -- would raise tax revenues by a combined $10.5 billion in 2012, or $107.5 billion over 10 years.

Extending depreciation of corporate jets, according to Republicans on Congress' Joint Economic Committee, would raise $300 million a year, or $3 billion over 10 years.

Three U.S. senators reached a deal on Thursday to repeal the $6 billion per year ethanol tax credit by the end of July, an agreement that must still be passed by Congress. The deal would reduce the federal deficit this year by $1.3 billion.

"We're spending most of our time talking about things that are in the millions and billions, when the real deal comes in the trillions ... That's corporate tax overhaul, changes to the tax structure, changes to entitlements," said Ed Mills, policy analyst at FBR Capital Markets. "A lot of this debate is as much about message as it is about substance."

A delicate political equation underlies the tax aspect of the debt ceiling debate. Republicans want to avoid being seen as defending specific tax loopholes, such as accelerated depreciation of corporate jets. But at the same time, they are determined not to be seen as supporting tax increases.

Democrats want to protect spending programs dear to their constituents while winning limited tax increases. Neither side wants tax hikes that choke off the sluggish economic recovery.

"It's possible that a final deal might throw a few crumbs at Democrats who want to change the tax subsidies for ethanol or oil companies. But this would be face-saving, hardly a major whack at corporate tax deductions," said Greg Valliere, chief political strategist at consultancy Potomac Research Group.

"The militance -- and unity -- of House Republicans has been underestimated. They're on a mission from God; they are determined to slash spending and have no stomach for tax hikes -- and they're utterly indifferent to the fact that their rigidity could cost them re-election next year," he said.

"They have veto power over any deal, so the revenue raisers will be modest and the spending cuts will be significant."

(Additional reporting by Richard Cowan and Timothy Gardner; Editing by Christopher Wilson)

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