President Barack Obama and his economic team are torn over whether to make overhauling the tax system a priority or relegate it to a brief mention in his annual State of the Union address, a top administration official said.

They are debating the risks if the plan fails to raise revenue that could be used to close trillion-dollar budget deficits, because the political pain may dwarf the fallout from last year’s healthcare overhaul, the official said.

Administration officials are conferring with corporate leaders after Obama met Dec. 16 with 20 executives, including the chiefs of Google Inc. and Cisco Systems Inc., on ways to fuel the economy. Dorothy Coleman, vice president of tax and domestic policy at the National Association of Manufacturers, said her group has spoken with administration officials about fundamental tax overhaul.

Treasury Secretary Timothy Geithner has invited the chief financial officers of companies to a Jan. 14 meeting to continue the discussion, a department spokeswoman said. Jade West, head of the Tax Relief Coalition, a group of about 1,000 trade associations, many of them small, said her group hasn’t been approached. “They’re talking to the large CEOs,” she said.

Assessing Republicans

Obama aides also are sizing up the newly empowered Republicans in Congress, including freshmen backed by the Tea Party movement. While Republicans’ cooperation is needed, many want any rewrite of the code to reduce taxes, particularly on corporations.

Representative David Camp, chairman of the tax-writing House Ways and Means Committee, urged Obama to make tax overhaul a priority in his State of the Union speech later this month.

“Presidential interest in tax reform can only be helpful,” said Camp, a Michigan Republican.

House Majority Leader Eric Cantor, a Virginia Republican, told Obama in a Jan. 5 telephone conversation that members of both parties would work with him on changes to tax laws.

Senate Majority Leader Harry Reid, a Nevada Democrat, said Jan. 6 that the tax system “is broken and needs to be fixed,” and “the country is ripe for tax reform.”

One immediate obstacle is whether rewrites of the corporate and individual tax codes can be accomplished in tandem. Camp said he wants to tackle both issues together, while the Obama administration is considering addressing corporate tax policy first. Corporations paid $225 billion in income taxes in fiscal 2009, compared with $1.2 trillion paid by individuals, according to the Internal Revenue Service.

S Corporations

It would be “difficult” to separate the issues, said NAM’s Coleman. “One of the problems that we face among our membership, for example, is that a lot of manufacturers are organized as S corporations and pay taxes at the individual rate.”

The administration is more interested in tackling the corporate tax code separately, the top official said. Confronting individual tax rates may put Obama in a political box because he promised not to increase taxes on the first $200,000 of an individual’s income and the first $250,000 earned by a married couple. In December, Obama also agreed to extend for two years the lower top marginal rates paid by those with the highest incomes. Earlier in the year, Obama won congressional approval of a new 3.8 percent Medicare surtax on top earners that is scheduled to take effect in 2013.

Panels’ Recommendations

Subsequently, two committees created by Obama suggested options for revamping the tax code. A panel headed by former Federal Reserve Chairman Paul Volcker said corporate tax rates could be reduced in exchange for closing loopholes that benefit only some industries.

And members of a deficit-reduction commission led by Erskine Bowles, a Democrat who was chief of staff to President Bill Clinton, and former Senator Alan Simpson, a Republican from Wyoming, urged a wholesale rewrite of the code that jettisons all tax expenditures to reduce rates across the board.

Obama hinted last month that he may engage the issue more directly.

“We’re going to have to have a conversation over the next year,” he told NPR on Dec. 10. “We can get some broad bipartisan agreement that it needs to be done. But it’s going to require a lot of hard work to actually make it happen.”

Obama, Camp and neutral observers say the political and economic landscapes are very different from the last time Congress rewrote the tax code. In 1986, President Ronald Reagan and Congress agreed to reduce income tax rates across the board, an accomplishment made possible largely by eliminating thousands of preferences and, ultimately, by raising taxes on corporations.

Narrower Window

Today’s lawmakers don’t have the same luxuries. The top individual marginal rate is 35 percent, or 7 percentage points higher than what was set in 1986, but below the 50 percent of 1985. Businesses are clamoring for relief from a top 35 percent corporate tax rate that is the highest in the developed world.

“We’re not taxed too little,” Camp said. Other factors, including a jobless rate hovering around 10 percent, the migration of businesses to individual tax rolls, and slow economic growth, mean that “here is a very different framework for looking at tax reform than 25 years ago.”

Alice Rivlin, who was President Bill Clinton’s budget director, said the White House and Congress must be open to raising additional taxes from an overhaul.

‘Growth-Friendly’

“Revenue-neutral isn’t what we need at the moment,” Rivlin said. “We need to find a way of raising more revenue, but with a more efficient and more growth-friendly tax system.”

The White House is wrestling, the official said, with whether additional revenue can be squeezed out of the existing income system or whether a new revenue stream levied on consumption, in the form of either energy taxes or a value-added tax, should be proposed. Advisers see little appetite to gut tax expenditures such as the mortgage interest deduction, and don’t envision the engine for a final deal, the top official said.

Camp said he will hold hearings on an overhaul of the tax code, a process begun in the Senate Finance Committee last year. It will take presidential leadership to jump-start the effort, analysts said.

“The president has really got to get behind this with a very detailed plan and really make it the focus of his administration,” said Howard Gleckman, resident fellow at the Urban Institute and editor of the TaxVox blog.

Political Hazards

The Obama administration is divided over whether to invest the political capital, Gleckman said, because advocating tax reform in the abstract draws applause, while getting down to the business of eliminating popular benefits -- such as subsidies for homeowners -- quickly wipes out the goodwill.

“Good tax reform may, in the long run, be very good for the economy,” Gleckman said. “In the short run, how do you argue scaling back the mortgage interest deduction, getting rid of private purpose tax-exempt bonds, whatever, is going to be good for the economy when the mortgage guys and the real estate people and others are just going to jump down your throat?”

Obama and Republicans must accept that they are going to create winners and losers if they are going to accomplish anything, said former Representative Jim McCrery of Louisiana.

“They won’t try if all they do is look at the obstacles,” said McCrery, the Ways and Means Committee’s top Republican in 2007 and 2008. “There’s so many. It’s just a huge undertaking.”

A Complicated System

McCrery said Republicans should consider accepting marginally higher taxes in the aggregate if the cost of complying with a complicated system is sharply reduced. In her annual report released Jan. 5, the IRS’s National Taxpayer Advocate, Nina Olson, estimated that Americans spend 6.1 billion hours annually complying with the law.

“Republicans may have to compromise toward a tax system that generates more revenues as a percent of GDP,” McCrery said. “But if they can get a tax system in return that is more streamlined, more efficient, less costly from a compliance standpoint, more competitive, more attractive for capital investment and therefore more likely to create good jobs, it seems to me that there’s a trade-off.”

In return, he said, Democrats would have to accept reductions in future entitlement spending.