Why Obama insists on higher tax rates for the wealthy

As the “fiscal cliff” draws ever-closer, President Obama has grown increasingly adamant that the wealthy pay higher tax rates, not just kick in more revenue. 

It’s the president’s one nonnegotiable: The wealthiest taxpayers must see their marginal rates rise, while everyone else’s remain at the reduced Bush-era levels. His definition of wealthy – individuals making more than $200,000, couples making above $250,000 – could get a tweak. (His ally Warren Buffett wants “wealthy” to start at $500,000.) 

And Mr. Obama might settle for a new top rate that’s shy of the 39.6 percent that ruled during the Clinton presidency, his spokesmen have suggested.

But the rate must go up.

Obama campaigned hard on raising taxes on the wealthy – that they pay their “fair share” – and won reelection. His job approval rating is on the rise. He has political capital to burn. So why is he burning it on the rate issue? Can’t he raise the revenue he wants – $1.6 trillion over 10 years – by limiting or ending wealthy taxpayers’ deductions, exemptions, and credits?

In a word, no. Certainly, he can raise a lot of money that way. And if he settles for less overall revenue in a deficit-reduction deal with the Republicans, in theory much of it could come from limiting or ending tax breaks. But by insisting that all the revenue come from the wealthy, he has no choice but to stand firm on higher rates.  

One prominent group, the Committee for a Responsible Federal Budget (CRFB), argues for keeping the current rates, and generating revenue by, for example, capping deductions at $25,000. That would bring in about as much revenue as putting the top 2 percent of taxpayers back on the Clinton rates – $950 billion over the next decade. It’s not $1.6 trillion, but it’s a start.

The CRFB argues that raising the top rates “could have some negative effects on people’s incentive to work or invest,” and economic growth could be harmed.

But the Obama White House isn’t swayed. And it’s already counting on reducing the value of tax deductions and other tax benefits to get to $1.6 trillion.

All these think-tank plans that promise to raise revenues without raising tax rates, they’re “always a little bit like Jell-O,” said Jason Furman, deputy director of the National Economic Council, in a White House briefing on Wednesday.

The idea, apparently, is that if you squeeze down on one part of a plan, a problem shows up elsewhere. The CRFB’s proposal to cap deductions at $25,000, for example, would produce a tax hike for 17 million families that make less than $250,000.  

“Forty percent of the revenue in this plan would come from those middle-class families,” and taking that revenue out of the equation reduces the value of the plan, he said.

Charitable deductions would also take a massive hit under the CRFB proposal.

“You look at the top 1 percent of households in this country – under this proposal, 97 percent of them would lose any incentive at all to give additional money to charity,” Mr. Furman said. Charities would take a $10 billion hit if the wealthy lost their deduction, he said.

Obama also made clear this week that he’s not about to gut charitable giving.  

“I can’t imagine there’s a person here who doesn’t sit on a number of not-for-profit boards, hospital boards,” Obama told corporate CEOs at the Business Roundtable. “In your respective communities, you are supporting an entire infrastructure that is the glue that holds our communities together. So the notion that somehow we’re going to just eliminate charitable deductions is unlikely.”

“What that means is, is that any formula that says we can’t increase tax rates probably only yields about $300 to $400 billion, realistically,” the president continued. “And that’s well short of the amount of revenue that’s needed for a balanced package.”

There’s also a healthy dose of politics in Obama’s insistence that tax rates go up on top earners. By making it his one nonnegotiable demand, chances are high that he will get at least something – if not a full return to the Clinton-era rate, then perhaps some midpoint between 35 and 39.6 percent. Any raise in tax rates would be a poke in the eye of Grover Norquist, author of the famous antitax pledge signed by most Republican legislators.

Obama also needs to keep an eye on his political base, which wants him to hang tough on tax rates, says Democratic strategist Peter Fenn.

“They worked their butts off to elect him,” says Mr. Fenn. “He’s got to stand up for them. If he stands up on this, then he has more wiggle room on entitlements and budget cuts.”