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Democrats aim tax, spending cuts at rich to avoid "meat ax"

By Richard Cowan and Thomas Ferraro

LEESBURG, Virginia (Reuters) - Facing government spending cuts that could delay air travelers, pare education programs for the poor and weaken military readiness, Democrats in the U.S. Congress this week sought to shift the deficit-reduction burden to the rich.

Without congressional action, about $85 billion in across-the-board spending cuts are set to begin on March 1. If allowed to continue, they could slow economic growth this year, according to the non-partisan Congressional Budget Office.

The savings, known in Washington as the "sequester," would cut into most military and domestic programs. Worse, they would be compressed into a short time frame of March 1-September 30, when Washington's fiscal year ends.

House Democrats have proposed substituting the $85 billion "meat-ax" approach to deficit reduction with a mix of spending cuts and tax hikes, although they acknowledge it is not clear if that will be embraced by President Barack Obama.

In a taunt to Republicans who oppose any tax increases to reduce deficits, Democrats are again aiming at squeezing more revenues out of the wealthy to help bring down the debt. It is a gambit they successfully deployed weeks ago when a "fiscal cliff" deal raised around $600 billion over 10 years by letting income tax rates rise on the highest earners.

"They (Republicans) have to tell the American people whether they care more about protecting special-interest tax breaks like those for big oil companies or whether they care about defense spending and economic growth," said Democratic Representative Chris Van Hollen of Maryland. He spoke to Reuters on the sidelines of a three-day House Democratic retreat.

Most of the Democrats' savings ideas already have been floated in past legislative debates.

Van Hollen, the senior Democrat on the House Budget Committee, said that under their plan, tax deductions for the very wealthy would be limited by phasing in a 30 percent effective tax rate for those earning more than $1 million a year.

This minimum tax would be separate from the income tax hike that started on January 1 for households with incomes above $450,000 a year.

These added revenues for the Treasury, Van Hollen said, would be further augmented by eliminating a long-held tax break for the profitable oil and gas industry. And on the spending side, Democrats would end government payments to farmers that are largely enjoyed by big agricultural operations.

Asked whether he thought Obama would publicly embrace these savings to head off the "sequester" possibly next week in his State of the Union address to Congress, Van Hollen said: "We don't know exactly." He added, "There are other things that could be put into the mix" as well.

Those, he said, could include cutting the "carried interest" tax break enjoyed by investment managers. It allows mostly affluent individuals to pay a 20 percent capital gains tax rate on a big chunk of their income, rather than the top ordinary income tax rate of about 40 percent.

Another Obama move, Van Hollen said, could be ending a tax break for corporate jets, an idea that was kicked around in 2011 and at one point was supported by some key Republicans.

Obama told the meeting of Democrats earlier on Thursday that he is willing to agree to a "big deal" with Congress on spending cuts and tax reforms to end uncertainty over the U.S. budget deficit, but insisted that new revenues be part of the package.

'DEFINITION OF DYSFUNCTION'

Republicans, however, are arguing that the window for tax hikes closed after Democrats successfully raised rates on the rich at the start of the new year.

"My constituents in Kentucky and the American people," warned Senate Republican leader Mitch McConnell on Thursday, "will not accept another tax increase to put off a spending cut that the two parties have already agreed to. It's the definition of dysfunction."

McConnell of Kentucky faces a possible Republican primary challenge in 2014 from the more conservative wing of his party.

But after significant victories in last November's elections that saw Obama win a second term and his fellow Democrats pick up seats in the Senate and House, Democrats are trying to block the non-military spending cuts that they argue will hit mainly the poor and middle classes.

Ratcheting up a public relations campaign to warn of heavy federal government job cuts, Maryland Democratic Senator Ben Cardin was to visit the National Institutes of Health in suburban Washington on Friday to discuss "how the latest federal budget battles and looming sequestration may affect you."

The Energy Department has notified its employees that it may have to place workers on temporary furloughs and slash "vital programs" if the across-the-board budget cuts take place as scheduled in March.

"Given that less than one month remains until these cuts would take effect ... our senior leadership team is engaged in extensive planning efforts to determine how we would deal with sequestration," Deputy Secretary Daniel Poneman said in an internal letter to department employees obtained by Reuters.

A new Hart Research poll released by Americans For Tax Fairness found that two-thirds of those surveyed support higher taxes on the top 2 percent and corporations, and that a majority opposes the Republican spending-cut-only approach.

Buoyed by that kind of poll, Obama on Thursday told House Democrats who are gathered here that he welcomed a budget debate in the "court of public opinion."

While he gave passing mention to reforming large government programs that Republicans want to cut for major savings - and where long-term deficit-reduction might be most achievable - the president mainly talked about reining in favorable tax treatment for the rich.

"We sure as heck should be willing to ask those of us who are luckiest in this society to close a few loopholes and deductions that the average American doesn't get," Obama said.

Republicans have argued that doing so would slow economic growth.

Democrats here countered that argument with a recently released government report in which a slight contraction in the economy for the last three months of 2012 was partially blamed on slowing government spending.

(Editing by Alistair Bell, Philip Barbara and Paul Simao)

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