Tax Loopholes Block Efforts to Close Gaping U.S. Deficit

WASHINGTON — As a member of the “Gang of Six,” Senator Mike Crapo of Idaho has emerged as something of a hero among advocates of bipartisanship, one of three conservative Republicans working with three Democrats to cut the deficit by closing loopholes that allow businesses and households to avoid paying taxes.

Yet earlier this year, the senator made sure that a $3 billion loophole — protecting “black liquor,” an alcoholic sludge used as fuel in timber mills and factories — remained open in the negotiations over the highway bill that President Obama signed this month. Many budget experts criticize the loophole as a tax dodge because it allows the sludge to qualify for an energy subsidy created to wean the country off imported oil for vehicles, which black liquor does not do.

On Capitol Hill, lawmakers casually point to closing loopholes as the answer to much that ails the country. Negotiations to avoid automatic military spending cuts in January, to enact sweeping deficit reduction and to lower corporate and personal income tax rates all hinge on closing unidentified loopholes.

But the back-room actions on black liquor point to just how difficult it will be to lower the budget deficit through painless changes in the tax code. Even for a self-proclaimed deficit hawk like Mr. Crapo, one man’s loophole can be another’s vital constituent interest.

An Idaho company “feared losing the write-offs could affect employment decisions,” said Lindsay Nothern, a spokesman  for Mr. Crapo.

Mr. Nothern would not identify the company, but Matt Van Vleet, a spokesman for Clearwater Paper, a Spokane company with a large pulp mill in north-central Idaho, confirmed that his company had gone to Mr. Crapo seeking to keep the tax break open.

“We would have felt significant pain,” he said.

Federal tax receipts are reduced by more than $1 trillion a year by various tax deductions and credits, known as tax expenditures, often tied to a policy aim. Ending them would nearly eliminate the federal deficit, which is projected to be $1.2 trillion in the current fiscal year.

But the three largest are as popular as they are expensive: the mortgage interest deduction has cost about $75 billion a year recently, the employer deduction for health care has cost $120 billion a year, and the charitable-giving deduction has cost $38 billion a year, according to the bipartisan Joint Committee on Taxation.

Others are more hotly debated, like the exclusion or deferral of taxes on overseas corporate earnings. Legislation by Senator Debbie Stabenow, Democrat of Michigan, to end a tax deduction for the expense of moving business overseas fell to a Republican filibuster in the Senate this week.

Still other tax breaks verge on the unpopular, criticized by aides of both parties. Offshore tax havens and other tax shelters cost the government about $150 billion a year, said Senator Kent Conrad of North Dakota, chairman of the Senate Budget Committee.

For tax aides in both parties, black liquor falls into the category of the hard to defend.

Mr. Nothern, the spokesman for Mr. Crapo, confirmed the senator’s role in the disappearance of the provision that would have eliminated the loophole, which happened sometime between its approval by the Senate Finance Committee and its arrival on the Senate floor this spring.

But he added that those actions bore no impact on the deficit negotiations that Mr. Crapo helped start. Mr. Nothern said in an e-mail: “Instead of discussing individual loophole closures to save a buck here or there (more than likely so the bucks can be immediately spent elsewhere), the Gang of Six and bipartisan partners remain talking about a much larger agreement — a simultaneous effort to agree on spending caps, tax reforms (including loophole adjustments and lowering of tax rates), plus reforms to Social Security, Medicare and related programs to keep them solvent.”

The company in question did not appear to be a political contributor to Mr. Crapo, but the forestry and forest products industry has given him $216,286 over his career, ranking 13th among industry givers, according to the Center for Responsive Politics.

Since the 1930s, the timber industry has used an alcoholic sludge produced as a byproduct of wood processing to power its mills and plants. In 2009, black liquor became something else — a tax haven. The timber industry labeled black liquor an alternative fuel under the provision Congress created to encourage ethanol production for cars and trucks. Congress never agreed, but the Internal Revenue Service did, backing the timber industry’s interpretation.

That year, black liquor cost the Treasury more than $4 billion.

Congress reversed track later in 2009, saying black liquor would not count as an alternative fuel after 2009, and lawmakers went further in the 2010 health bill, also barring the timber industry from claiming black liquor as a cellulosic biofuel, which receives even bigger tax advantages.

But the I.R.S. gave black liquor one last chance. It ruled that the health care provision did not prevent the timber industry from redefining black liquor produced in 2009 as a cellulosic fuel, worth $1.01 a gallon, even if a company had claimed it as a regular alternative fuel, worth 50 cents a gallon. In other words, companies were permitted to give back one credit already claimed for another worth double, a $2.8 billion bonus for the industry.

Senator Max Baucus of Montana, chairman of the Finance Committee, saw the money as a way to help pay for a transportation bill this year. But Mr. Crapo protested, saying at a hearing that changing the law would “cause very significant damage to a number of people and impact jobs around the country, not the least of which is a major facility in my state.”

Mr. Baucus, a Democrat, tried to assuage his colleague’s concern, whittling down the black liquor provision to save $1.6 billion. It still was not acceptable. Finance aides said a bipartisan vote on the committee was more important than a fight over black liquor. By March, the bill reached the Senate floor with the provision gone, and Mr. Crapo was the first Republican to back the Baucus measure.

In the demise of the provision, members of the Gang of Six, including Mr. Crapo, see a cautionary tale: Go big or don’t go at all. Little provisions can be picked off by members in ways that a comprehensive deficit reduction cannot, they say.

Senator Richard J. Durbin, Democrat of Illinois, who is participating in the deficit talks with Mr. Crapo, said: “We have to invite the American people to be part of a conversation about how to rationalize this tax code, reduce its complexity, try to bring rates down in a reasonable way and still reduce the deficit.”

He added: “I drink red wine. I’m not into black liquor.”