By Virginia Ainslie

Today, the White House announced that changes to the Bush tax cut extensions negotiated last December are not a part of the debt ceiling negotiations.  Not a surprise, but a move that increases pressure on negotiators to put together a set of changes in tax credits, tax subsidies, and other special interest tax breaks that can generate enough revenue to close the deal. 

While these changes wouldn’t change overall individual or corporate tax rates, they would impose higher taxes on affected businesses and possibly, on the wealthiest Americans.  Many Republicans continue to argue that such changes constitute tax increases, and therefore can’t pass. 

Democrats counter that the burden for bringing order to the federal budget must be a “shared sacrifice that balances the pain”.  Democrats remain determined that low income and middle class taxpayers not bear the brunt of this deal. 

While Republicans remain firm in their insistence that “tax increases are off the table” and can’t pass the House, Democrats point out that a “spending cut only” deal can’t pass the Senate.

Speaker Boehner is unlikely to secure any agreement with President Obama and Senate Majority Leader Reid that can garner 208 Republican votes in the House.  Therefore, Boehner will need House Democratic votes to get any deal through his chamber, just as he did for passage of the FY 2011 CR last April.   However, House Dems won’t support a “spending cut only” deal either.  In this sense, Boehner’s hand is not as strong as GOP rhetoric might imply.

Pelosi and McConnell remain the wild cards in these negotiations.  Help from both will be necessary to assure timely passage of an increase in the debt ceiling.  However, such “help”  might only go as far as agreement not to actively oppose the deal.  Advocacy in support of any deal from either of these parties is very unlikely.

In talks with President Obama and VP Biden Monday Evening, McConnell peremptorily rejected any deal that would include revenues from changes in tax credits, tax subsidies or special interest tax breaks.  Democratic scorn over presumed Republican preference for big businesses, billionaires, and millionaires over “average Americans’ already is being heaped on Republicans, including McConnell,  who continue to insist closing tax loopholes and eliminating tax expenditures off limits.

McConnell’s meeting with the President stretched more than an hour, and was preceded by a hostile McConnell Senate floor speech and an opinion piece posted on CNN.com demanding that “tax hikes come off the table”.

How much of this is theater intended to inoculate McConnell from Tea Party criticism remains to be seen.  Still, this stance signals that Senate Minority Leader McConnell will play a larger role in the debt ceiling talks that he did in the FY 2011 CR negotiations.

Pelosi continues to demand that no further cuts be made to Medicare, but it sounds like the tentative agreement on savings already reached by the Biden Group negotiators includes such cuts.

Cuts to Medicaid, especially relaxation of the so-called Maintenance of Effort (MOE) requirements in the new health reform law, are all but inevitable.  States simply don’t have the money to continue current broad eligibility criteria for Medicaid assistance.  Both Democratic and Republican Governors have pleaded for a change in these requirements.

The tax expenditure proposals now under discussion include the following:
Democrats want to eliminate “Last-In-First-Out (LIFO)” accounting—tax benefits to oil companies and other inventory-intense businesses that isn’t allowed by international accounting rules—and a series of tax breaks that affect oil and gas industries. Those two changes could raise as much as $119 billion over the 10 year timeframe of debt ceiling negotiations.

Democrats also propose slowing tax depreciation on certain business investments, including private jets;  taxing profits that accrue to private-equity bankers as income, not capital gains;  and instituting a risk-adjusted fee on financial institutions. Those three proposals, depending on how they are implemented, could raise as much as $334.5 billion.

Other more technical tax expenditure proposals include modifying the federal government’s official inflation index to more accurately measure changes in the cost of living. This would result in lower spending on federal benefits, including Social Security, but would also cause income tax brackets to grow more slowly.  Total savings from this proposal is estimated at $71.8 billion over 10 years.

An Obama proposal to change the treatment of tax deductions for certain high income earners has been offered, but is meeting stiff resistance in the latest round of talks.  This proposal would limit deductions for Americans earning more than $250,000 a year down to 28%, from the current rate of 35%.  This change would increase federal revenue by some $300 billion over a decade.

Charitable organizations oppose this change, fearing it would reduce the amount of gifts and contributions made by wealthy Americans.

Negotiators at the debt-reduction talks also considered limiting the home mortgage interest deduction,  as well as a broader limit that would apply to taxpayers who earn over $500,000 in a year.  Although these changes don’t seem to have been taken off the table, they aren’t getting any support from Republican negotiators,  at least not yet.

Former Senator Alan Simpson (R-WY) and former Clinton Chief of Staff Erskine Bowles, who co-chaired the President’s bipartisan deficit commission last year, issued a statement Monday in support of a two-part deal that includes spending cuts and changes to entitlements now in the amount of at least $2 trillion, combined with a hard agreement to tackle another $2 trillion in savings before the election in November, 2012.

While this is similar to a proposal made last week by Senate Minority Leader McConnell, it is getting no traction – at least so far – in the House, where Members up for re-election next year can’t stand the thought of being “put through this wringer twice”.  Most Senators of both parties also appear to prefer one big, enforceable, deal now - if at all possible.

While agreement on a major deficit reduction and debt ceiling increase deal remains possible in the next month, it will take considerable time to put such an agreement into legislative language.  Members of Congress are often reluctant to make a commitment to vote for amy complex package until they see exactly how this language is written.  It could take 3 weeks to get legislative language completed, and up to a week to get enough support for it to pass in both chambers.  For these reasons, the sooner a deal is reached, the better.

A major Social Security payout is scheduled for August 3rd, and could be delayed if an agreement isn’t enacted by the August 2nd deadline.