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ANALYSIS-'Fiscal cliff' deal sours U.S. tax reform outlook

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* Hopes dim for 'grand bargain' on taxes, spending

* Democrats want more revenue from tax code revamp

* Republicans say "cliff" deal means tax debate over

* Gridlock may mean corporate tax reform hopes dashed

By Kim Dixon and Kevin Drawbaugh

WASHINGTON, Jan 7 (Reuters) - Prospects for a 2013 overhaul
of the U.S. tax code have faded after last week's "fiscal cliff"
fight, with Democrats still pushing to raise more government
revenue by closing tax breaks and Republicans arguing that the
tax debate is over.

The stand-off is crushing any modest post-election hopes
that Washington could summon the political will needed for a
comprehensive clean-up and simplification of the tax system.

In particular, the toxic atmosphere is denting any hopes of
an overhaul of the corporate tax system by cutting the 35
percent rate, one of the highest in the world, while getting rid
of a large number of tax breaks and shelters that mean many
companies pay a much lower effective rate.

"Maybe there will be some breakthrough I can't imagine...I
just don't see it right now," said Bob McIntyre, head of
Citizens for Tax Justice, a left-leaning tax think tank, who
helped shape the last major tax reform - 26 years ago.

Some tax experts, economists and analysts now fear 2013
could witness a series of narrow agreements made in the face of
imminent crises, far from the "grand bargain" some had seen as
possible before the stop-gap deal on New Year's Day.

"I suspect the deal has reduced the odds of fundamental tax
reform this year," said Donald Marron, director of the Tax
Policy Center, a think tank, and a former senior economic
adviser to Republican President George W. Bush.

Few things impose more cost and confusion on the economy
than the complex, ever-shifting tax code. It has not been
rewritten since 1986, when Republican President Ronald Reagan
and congressional Democrats teamed up to raise taxes on
business, cut them on everyone else and closed many loopholes.

Lawmakers from both parties have agreed for years that
another overhaul is badly needed. The tax-writing committees in
Congress held several hearings last year intending to lay the
groundwork for a big push on tax reform in 2013.

Then came the frantic deal hatched a week ago by Vice
President Joe Biden and Senate Republican Leader Mitch McConnell
to avert the sharp tax increases and severe spending cuts
threatened by the "fiscal cliff."

Dubbed Biden-McConnell, the pact raised ordinary income
taxes on household incomes over $450,000 and protected wage
incomes below that level from tax hikes. These steps fulfilled
campaign promises made by President Barack Obama and represented
a defeat for Republicans who had fought tax hikes of any kind.

RUM, RACE TRACKS AND RESTAURANTS

Biden-McConnell also extended tax breaks for NASCAR race
tracks, for Puerto Rican rum output, for film and television
production, and for retail and restaurant improvements, among
other small tax expenditure provisions - reminding Americans of
how riddled the tax code is with special favors.

No mention was made in the deal of ending tax breaks long
criticized by Obama, such as the "carried interest" provision
that lets senior managers of private equity firms pay the lower
capital gains tax rate on much of their income. His Republican
opponent in last year's presidential election, Mitt Romney, had
benefited from that provision because of his earlier role as
co-founder of Bain Capital.

At the same time, Biden-McConnell put off for two months
deep spending cuts known as the "sequester" and did next to
nothing to reduce the deficit.

The next test of whether Congress is able to do more than
patch things over for a few weeks will come in late February and
early March, when the "sequester" returns; the government again
hits its borrowing limit; and funding for the government
expires. All three will require congressional action.

Looking toward that, McConnell on Sunday ruled out raising
tax revenues on top of the Biden-McConnell tax hikes and said
the full focus must now be on spending cuts to curb the deficit.

"The tax issue is finished. Over. Completed," McConnell, of
Kentucky, said on ABC's "This Week With George Stephanopoulos."

Republicans are seeking cuts in the Medicare healthcare
program and the Social Security pension program as a condition
for raising the borrowing limit. Obama has said he will not
negotiate over this. Democrats have vowed to keep pushing for
more tax revenue, as well as spending cuts, to curb deficits.

House of Representatives Democratic Leader Nancy Pelosi, on
CBS's "Face the Nation," said Democrats want "everything on the
table from the standpoint of closing loopholes ... Special
subsidies for big oil, for example, $38 billion right there."

CORPORATE CODE EYED

Many in the business community want a cut in the corporate
income tax rate. Few corporations actually pay that rate, thanks
to tax breaks they use to lower their effective rates, sometimes
to zero. But the rate is among the world's highest.

The White House unveiled a corporate tax plan in February
that has gathered dust for months. Obama has agreed to a lower
corporate rate and pledged to pursue that. Beyond such general
commitments, however, the details get complicated.

Multinational corporations have pushed for years for a new
system to allow them to bring back profits earned overseas at a
zero or very low rate of U.S. tax, b u t companies with chiefly
domestic markets are less committed.

Citizens for Tax Justice, a non-profit research and advocacy
group, has estimated that 290 major corporations have
collectively held nearly $1.6 trillion in profits outside the
United States at the end of 2011. As long as these earnings are
parked offshore, these Fortune 500-ranked companies do not have
to pay corporate income tax on them.

House Ways and Means Committee Chairman Dave Camp, a
Michigan Republican, has a plan to revise international
corporate taxation, but business groups have been unable to
agree on a key detail that would get Democrats on board: how to
prevent further movement of businesses to other countries.

Moreover, corporate lobbyists readily admit that cutting
corporate taxes while raising individual taxes - not only on
high-income earners, but also on wage earners with the
expiration last week of Obama's brief payroll tax holiday -
would not be a winning political argument with voters.

"An essential ingredient to reform is an agreement on how
much tax the system needs to collect," said Clint Stretch,
former counsel for Congress' Joint Committee on Taxation.

The "fiscal cliff" deal did not produce that, he said.
"Republicans will likely dig in harder on no more new taxes."

(Additional reporting By Patrick Temple-West and Rachelle
Younglai.; Editing by Martin Howell and Leslie Gevirtz)

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