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Closing Tax Loopholes Easier In Theory Than In Political Practice

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As leaders in Washington try to make a deal to avoid the automatic tax hikes and spending cuts slated to go into effect in the new year, one major focus of the negotiations is whether to let taxes go up on the rich.

The Obama administration wants to allow the Bush-era tax cuts to expire for top earners. House Speaker John Boehner and congressional Republicans have countered with a proposal that they say would raise revenue through ending loopholes and deductions in the tax code and would not increase tax rates.

But closing loopholes is easier said than done. One man's loophole is another's vital economic incentive.

This week alone, hundreds of nonprofit leaders will be descending on Washington, intent on protecting the tax breaks for charitable contributions.

And making changes in the tax code could also poke a hole in a lot of household budgets.

Just ask Luke Lackrone. The software manager was shocked two years ago when his family moved from Arizona to Maryland, where he found that a modest, three-bedroom townhouse costs $450,000.

"It's nice. It's comfortable. But it's not like we're just swimming in space. Or we have a swimming pool or something like that," he says.

The Maryland house did come with one extra feature: a pretty hefty property tax bill.

"Property taxes for my home in Maryland are four times what they were in Phoenix," he says.

Still, Lackrone took some comfort in knowing he could write off both his property taxes and his mortgage interest every year when he files his federal tax return. Those deductions were a big part of making his home purchase pencil out.

"Our overall monthly payment will be this number, but it's really like it's much less, because we get that tax benefit for all the interest," he says. "It was absolutely a part of our decision-making."

That's why Lackrone worries when he hears politicians talk about limiting tax deductions. While Democrats are intent on raising the top income tax rates, arguing the wealthy can afford to pay more, congressional Republicans insist the government should leave rates alone, and raise money if it must by closing loopholes.

The GOP does have some economic rationale. Bob Williams of the nonpartisan Tax Policy Center says in theory it makes sense to keep tax rates low while minimizing deductions and other "loopholes."

"Lower rates and broader base means less distortion, less tax influencing how the economy comes out," he says.

One could argue, for example, that the mortgage interest deduction simply encourages people to go deeper in debt and buy more house than they otherwise would. Most tax breaks are designed to encourage some kind of behavior, whether it's owning a home or giving to charity. And once enshrined in the tax code, those breaks are mighty hard to get rid of.

Nonprofit leaders will be storming Capitol Hill this week, fighting any attempt to whittle away at the deduction for charitable giving.

"People are saying to us, 'Stand from the highest treetop and yell that this is going to hurt the people that we serve,' " says Diana Aviv of Independent Sector, an umbrella group for the nation's charities.

"The charitable deduction is likely to be the first one on the chopping block by individual choice," she says. "People give, but they give more generously because they're incentivized to give. If they're not incentivized to give, they'll give less."

The centrist Democratic group Third Way tried to avoid this kind of hostile reaction when it proposed its own cap on itemized deductions. Third Way Vice President Jim Kessler says his group deliberately left the tax break for charities alone.

"You don't want every charitable organization from the New York City Ballet to your local soup kitchen and the Catholic Church opposing it," he says.

But charities aren't the only ones on alert. The National Association of Realtors is keeping its powder dry for the moment but says it will be vigilant in opposing any effort to limit the mortgage interest deduction.

There is a lot of money at stake. The Tax Policy Center says capping deductions at $25,000 per household would bring in more than $1 trillion over a decade. But more than a third of that extra revenue would come from people making less than $250,000.

White House spokesman Jay Carney says that's a problem with the GOP approach.

"You cannot get the kind of revenue that you need simply from capping deductions or closing loopholes without taxing the heck out of the middle class — and that's unacceptable for the president — or without ending the charitable deduction or doing other things that would never fly on Capitol Hill, for good economic as well as political reasons," Carney says.

Still, Obama also wants to raise more than half a trillion dollars by liming tax breaks only for the wealthiest families, so some adjustment to popular deductions is likely to be part of any eventual budget compromise.

Lackrone, who's still adjusting to Maryland's high-priced real estate, says he'd be willing to pay higher income taxes. Just don't mess with his mortgage interest deduction.

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