Jonathan Chait

The Secret Issue At The Heart Of the Budget Fight

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David Rogers pulls out an under-reported point about what killed the deficit bargain between President Obama and John Boehner:

For many observers, tax reform remains the last, best bet even now to bridge the revenue differences between Republicans and Obama and craft an effective deficit-reduction package. But there’s resistance from wealthy interests who fear the president will gain too much leverage to impose tougher standards of progressivity in the tax code and thereby crimp their capital gains tax breaks.

The White House and Boehner admit the progressivity fight contributed to the breakdown in their talks Saturday. And it may help explain why The Wall Street Journal’s editorial pages a major force for the GOP and big proponent of favorable capital gains rates so strongly attacked Boehner on Saturday and then came out Wednesday in defense of McConnell’s attempts to kick the debt fight past next year’s elections.

Let me explain this one to laypeople. Obama's deal on taxes was that he proposed to start with the revenue levels we'd have if the Bush tax cuts only on income over $250,000 phased out. But, to assuage Republican concerns about higher tax rates, he agreed to tax reform that would drop the rates back down to Bush-era levels, and make up the lost revenue by closing tax preferences.

Now, here is where things broke down. To do that in a way that means the progressivity of the tax code, you'd almost be required to reduce or eliminate the tax preference for capital gains. That's how the Reagan administration and Democrats did it when they reformed taxes in 1986 -- they dropped the top tax rate from 50% to 28%, but the rich wound up paying more because they ended the preference for capital gains.

This, however, is a a huge bugaboo to the right. Since 1986, the GOP has obsessively and successfully crusaded to re-open the capital gains tax preference. Most of the very, very rich get the bulk of their money from capital gains. There's nothing they'd like less than ending that preference.

The broader problem here is that Obama seems to be taking Republicans at their word. He wants shared sacrifice, and they say they want to avoid high rates. Tax reform is a way t accomplish both. But Republicans don't just want to avoid high marginal tax rates. They want rich people to pay low taxes, period. It's not clear Obama understands that.

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