A Look Inside the Super Committee

The GOP opposes raising tax rates, but one idea being considered is limiting deductions as a percentage of income.

By Stephen Moore
WSJ.com

'I can find $1.5 trillion of budget savings in my sleep," says Jeb Hensarling, the Republican co-chairman of the 12-member deficit reduction committee. "The hard part is getting six Democrats to agree to do it."

If he can't, there will be no consensus on a plan to reduce deficits over the next decade and the so-called super committee will surely blow up, just as most on Wall Street and in Washington are betting will happen. To beat the statutory deadline for a congressional vote before Thanksgiving, a deal, if there is one, will almost surely have to be struck by the end of this week.

Insiders on the panel say that the deal being offered by Democrats is less than $1 of spending cuts for every $1 of new taxes. Democrats want to count the $900 billion of discretionary spending cuts already agreed to in the debt bill and $1 trillion in troop withdrawals from Afghanistan and Iraq, which may not happen. Meanwhile they are insisting on close to $1.2 trillion of tax increases in exchange for less than $1 trillion in entitlement reforms. The president's own deficit reduction committee, Simpson-Bowles, offered $2 of cuts for every $1 of new taxes. The GOP House budget passed last spring contained some $4.5 trillion in cuts—three times more than the super committee must find.

Democrats also keep pressing for higher tax rates on the rich. "We have no intention whatsoever of raising tax rates—period," Mr. Hensarling states emphatically.

But raising rates and raising revenues are different. Eliminating loopholes in exchange for making the Bush tax cuts permanent after 2013 is on the table—and by broadening the tax base, this could bring in tens of billions of new revenues each year. Says Mr. Hensarling: "Republicans want more revenues. We want more revenues by growing the economy; we're not happy with revenues at 14% of GDP, but we don't want to do it by raising rates."

One positive development on taxes taking shape is a deal that could include limiting tax deductions, perhaps by capping write-offs on charities, state and local taxes, and mortgage interest payments as a percentage of each tax filer's gross income. That idea was introduced on these pages by Harvard economist Martin Feldstein.

In exchange, Democrats would agree to make the Bush income-tax cuts permanent. This would mean preventing top rates from going to 42% from 35% today, and keeping the capital gains and dividend tax rate at 15%, as opposed to plans to raise them to 23.8% or higher after 2013.

And there is some indication that corporate rates might actually be pushed lower. Republicans would agree to a broader tax base and Democrats would accept a rate of between 25% and 28%, down from 35% now.

One member of the committee tells me on background that this means getting rid of certain deductions, including immediate write-offs of capital purchases, write-offs for interest expenses, and green energy subsidies in the tax code that can drive effective tax rates down to zero for major U.S. firms. He says this is an area where progress is being made.

Another policy Republicans are fighting for is allowing corporations with foreign subsidiaries to repatriate capital back to the U.S. at a one-time tax rate of 5.25% (on income already taxed once in the country of origin) instead of having to pay a charge as high as 35% today.

The big fiscal breakthrough Mr. Hensarling and his GOP colleagues are hoping for on the spending side of the ledger is first-stage reforms in the big three entitlements—Medicare, Medicaid and Social Security.

Republicans want a gradual rise in the retirement age for the giant cost drivers Social Security and Medicare; higher co-pays and premiums for Medicare; and a tweak in the cost-of-living benefit formula to more accurately reflect the real inflation rate.

A change in the index formula (substituting the rise in prices rather than the rise in wages) to calculate benefits for Social Security and other federal programs would save about $200 billion over the next decade. And it would reap two to three times more in future decades. As Mr. Hensarling puts it, these reforms "are huge, because they start to bend the cost curve downward on the big entitlements."

Changes to entitlements should hardly be considered partisan, he adds. "You've had the president of the United States himself say, the biggest drivers of our fiscal insolvency are Medicare, Medicaid and our health-care programs," Mr. Hensarling says. "He's also acknowledged that . . . tax increases alone are not going to be able to help."

Nevertheless, Democratic negotiators on the panel won't acknowledge that fiscal fact of life. They insist that those who lose health-care benefits under Medicare or Medicaid be moved into the subsidy system under ObamaCare, which negates most of the budget savings. And they've taken any reforms of the $2.4 trillion ObamaCare program off the table. The White House, meanwhile, has not participated in the negotiations, which irks GOP negotiators.

If there is no deal, there will be a $1.2 trillion sequester of spending over the next 10 years with nearly $600 billion coming out of the defense budget. Mr. Hensarling fears those cuts to the military would be "draconian," but he adds, "I have a hard time believing a 10-year sequester of national defense of that magnitude would ever happen." He says, "At some point the American people rise up and say 'Wait a second, we continue to live in a dangerous world, this is not smart.'"

Does Mr. Hensarling think there will be a deficit agreement? "Our backs are finally against the wall," he says, and both sides are "finally starting to get serious." Still, his expectations are modest. "We're not going to be high-fiving each other over any deal that's reached."

Mr. Moore is a member of the Journal's editorial board.