Amid Supercommittee Wrangling, Tax Reform Gains Momentum

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J. Scott Applewhite / AP

Supercommittee member Sen. Max Baucus, D-Mont., second from left, holds his hand out as he questions Congressional Budget Office Director Douglas Elmendorf, on Capitol Hill in Washington, Oct. 26, 2011.

Whether or not Congress’s deficit supercommittee succeeds in finding $1.2 trillion in savings by Thanksgiving, one likely result is that sometime in the next 18 months, Congress will tackle tax reform.

There are already many areas of agreement between Senate Finance Committee Chairman Max Baucus, Democrats’ top tax writer, and Republican Rep. Dave Camp, his counterpart on the powerful House Ways and Means Committee. Over the last year, both men have held a series of hearings on the issue. Tax reform isn’t something that should be done hastily– just look at the Savings & Loan Crisis produced by the rushed tax reform process in 1986 – but with so much already discussed, a comprehensive overhaul is already well on it’s way. So much is apparent in the current supercommittee negotiations.

Last week, deficit negotiators from both sides unveiled their offers. Dems proposed a $3 trillion-deficit cutting plan and Republicans proposed a $2.2 trillion version. The biggest difference? Taxes. The seemingly wide rift on this issue was on display at a public hearing Tuesday, during which Texas Rep. Jeb Hensarling  sharply told Senator Patty Murray,  “Certainly we cannot tax our way out of this crisis.” But this sparring belies the state of near-consensus on tax reform. There’s now enough agreement that if Republicans were to give an inch on revenue, a deal could quickly be achieved.

(MORE: Tax Reform and the Revenue Problem)

If the supercommittee does come to an agreement, it will likely include $800 billion in new revenue that House Speaker John Boehner and Majority Leader Eric Cantor discussed with the White House during the summer’s heated debt ceiling talks. Assuming the agreement is passed by both chambers, the supercommittee would send instructions on tax reform to the relevant Congressional committees, which would then spend much of next year enacting tax reform. There are two sticking points: Democrats are demanding a few hundred billion dollars in revenue increases up front, which would be achieved in part by doing away with the  flashy deductions for the rich that they’ve been harping on for months–breaks for corporate jets, race horses and carried interest. And Democrats also want to start the tax debate from a baseline that assumes the expiration of George W. Bush’s 2001 tax cuts, which are up for renewal next year. Republicans don’t like either of these requirements, which is why, a senior Senate source close to the talks tells me, there’s a 75% chance that the supercommittee will deadlock (up from 70% two weeks ago).

But in recent days, a bevy of Republicans, including former Wyoming Senator Alan Simpson, Georgia Senator Saxby Chambliss and former New Hampshire Senator Judd Gregg, have argued, as conservative New York Times columnist David Brooks did during the summer’s heated debt ceiling negotiations, that Republicans would be crazy to walk away from a deal that would deeply cut the deficit while only moderately raising taxes. Even John Boehner this week pushed for the supercommittee to come to an agreement, and GOP sources hinted that their party  might give ground on the revenue front. The thinking goes that if Republicans cut a deal, they’ll get entitlement reform. Even changes to Social Security, which Democrats had long refused to consider, are now on the table. And if they don’t make one, tax reform will likely be enacted anyway without major tweaks to federal benefit programs. That’s why House Republican sources tell me the committee is likely to reach a deal.

As for the remaining areas of disagreement, without President Obama in the room to give away the farm, Democrats have the upper hand and are holding the line on revenue. Any movement will likely have to come from Republicans, who have more incentive to make concessions than Dems do. If the committee deadlocks, $1.2 trillion in cuts to entitlements and defense spending will automatically trigger in January 2013. Because the entitlement cuts won’t affect benefits, only providers, Democrats would not have a hard time accepting such an outcome. Republicans, on the other hand, loathe the Pentagon cuts.

(MORE: Warren Buffett and the Supercommittee)

The bad news for Democrats if the committee deadlocks could be the market reaction. Dems have spent the last few months making overtures to the ratings agencies and they believe that there will not be a credit rating downgrade if the committee fails to reach an agreement. But Wall Street reacted to August’s debt ceiling debacle by dropping hundreds of points. Even with prospects for tax reform looking up, that kind of market disruption is the last thing President Obama wants going into election season.