1 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers Six Principles for Tax Expen diture Reform Common-Sense Guidelines for Policymakers as They T ackle Badly Needed Reform of Hidden Tax Code Spending By Seth Hanlon October 2011 Te ederal governmenspends more han $1 rillion every year hrough special provi- sions ohe Inernal Revenue Code . Called ax expendiures, hese provisions have gen- erally received ar less scruiny han oher orms ogovernmenspendin g, parly because hey are hidden in he ax code. Along las, policymakers ocused on decireducion are discovering haax ex pendiures can no longer be ignored ihe Unied Saes is o achieve scal susainabiliy over he long erm. “ax expendiure” is he echnical erm or special ax breaks hacome in he orm oexclusions, deducions, credis, preeren ial raes, or deerrals oax liabiliy. Teyare called expendiures because hey are uncionally he same hing as direcgovern- menspending, as economiss have long recognized. Ihe governmensubsidizes an aciviy by spending money on idirecly, or by carving oua special ax break or i, he eecis he same. Individual and corporae income ax expendiures, measured by he size ohe revenue loss o he ederal governmen, add up o abou$1.1 ril lion. Ta’s abouhree-quarers ohe amounhe ederal governmenwill acually collecin income axes his year. And i’s abouwice he budgeor all ederal “domesic discreionary” spending, which unds criical public invesmens and services including ransporaion and inrasrucure, public healh and medical research, edu- caion, housing, environmenal proecion, ood and drug saey, law enorcemen, and veerans services. Figure 1 Major categories oederal spending, iscal year 2010 Source: Budget othe United States Government, Fiscal Year 2012, Tables S-4 and 17-1. 0 200 400 600 800 1000 1200 Defense and security Medicare and Medicaid Social Security Other mandatory programs “Domestic” discretionary programs Interest on the debt Tax expenditures, combined total In billions
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8/3/2019 Six Principles for Tax Expenditure Reform
1 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
Six Principles for Tax Expenditure Reform
Common-Sense Guidelines for Policymakers as They TackleBadly Needed Reform of Hidden Tax Code Spending
By Seth Hanlon
October 2011
Te ederal governmen spends more han $1 rillion every year hrough special provi-
sions o he Inernal Revenue Code. Called ax expendiures, hese provisions have gen-erally received ar less scruiny han oher orms o governmen spending, parly because
hey are hidden in he ax code. A long las, policymakers ocused on deci reducion
are discovering ha ax expendiures can no longer be ignored i he Unied Saes is o
achieve scal susainabiliy over he long erm.
“ax expendiure” is he echnical erm or special ax breaks ha come in he orm
o exclusions, deducions, credis, preerenial raes, or deerrals o ax liabiliy. Tey
are called expendiures because hey are uncionally he same hing as direc govern-
men spending, as economiss have long recognized. I he governmen subsidizes an
aciviy by spending money on i direcly, or by carving ou a special ax break or i,he eec is he same.
Individual and corporae income ax expendiures,
measured by he size o he revenue loss o he ederal
governmen, add up o abou $1.1 rillion. Ta’s abou
hree-quarers o he amoun he ederal governmen
will acually collec in income axes his year. And
i’s abou wice he budge or all ederal “domesic
discreionary” spending, which unds criical public
invesmens and services including ransporaion and
inrasrucure, public healh and medical research, edu-
caion, housing, environmenal proecion, ood and
drug saey, law enorcemen, and veerans services.
Figure 1
Major categories o ederal spending, iscal year 2010
Source: Budget o the United States Government, Fiscal Year 2012, Tables S-4 and 17-1.
0
200
400
600
800
1000
1200
Defense
and security
Medicare
and Medicaid
Social
Security
Other
mandatory
programs
“Domestic”
discretionary
programs
Interest on
the debt
Tax expenditu
combined to
In billions
8/3/2019 Six Principles for Tax Expenditure Reform
3 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
Tis poin was underscored by a panel o prominen economiss and ax expers esiying
beore he Senae Finance Commitee on Sepember 13. As ormer Federal Reserve Board
Chairman Alan Greenspan old he senaors:
Cuts in tax expenditures can be alternatively structured, and viewed, as cuts in out-
lays rather than a reduction in revenues. Te deduction for interest on home mort-
gages, for example, could just as easily have been reconstituted as a subsidy payment to homeowners. Similarly, oil and gas depletion allowances could be restructured as
subsidies to producers.
Presiden Ronald Reagan’s chie economic advisor, Marin Feldsein, likewise esied ha
when ax expendiures are reduced, “he economic eec is he same as any oher reduc-
ion in governmen oulays.” And Edward Kleinbard, ormer direcor o Congress’s Join
Commitee on axaion, explained ha “deliberae Congressional subsidy programs baked
ino he ax code…are a orm o governmen spending, no ax reducions.”1
Once you recognize ha ax expendiures are simply a hidden orm o spending, i makes nosense o slash ederal programs and enilemens while leaving ax expendiures o he able.
Tis is especially rue because he Budge Conrol Ac, enaced in Augus, subjecs oher
crucially imporan ederal programs o signican cus in he coming years. Caps imposed
by he Budge Conrol Ac will cu discreionary spending by nearly $1 rillion over he
nex 10 years. Te resul is ha discreionary spending would decline rom 9 percen o
gross domesic produc, or GDP, o abou 6.2 percen by 2021, which, as Congressional
Budge Oce Direcor Douglas Elmendor noes, is “ well below he 8.7 percen average
over he pas 40 years.”2 Wih discreionary spending already subjec o hese caps, uure
deci reducion mus be balanced across he ederal budge, including on he revenue sideo he ledger. o be sure, he bes and mos sraighorward way o raise signican revenue
migh simply be o allow he Bush ax rae cus or op income earners expire on schedule
a he end o 2012. Bu even hose who are adaman abou keeping all ax raes where hey
are now should be open o reducing hidden ax code spending.
Ta doesn’ mean ax expendiure reorms need o happen now. Te op prioriy oday
should be job creaion, no deci reducion. And overly severe cus o ax expendi-
ures, like all scal conracion, should be avoided in he near erm while he economy
sruggles o recover. Bu lawmakers should pursue an approach ha gradually reorms or
phases ou ineecive ax expendiures.
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4 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
Like all forms of s pending, tax expenditures should be assessed for cost
effectiveness
When he governmen delivers ax preerences o cerain axpayers, i increases he
burden on all oher axpayers (or, given oday’s decis, on uure axpayers). Congress
mus hereore exercise jus as much diligence wih ax expendiures as i does wih
ederal programs ha spend money direcly.
Ta means ha each ax expendiure should be evaluaed or cos eeciveness. As
wih direc governmen spending programs, some ax expendiures are more eecive
han ohers. Some are vially imporan and some are waseul or poorly designed.
Some help low-income amilies work heir way ou o povery, while ohers pad he
pros o he larges companies in he world. We mus disinguish meriorious ax
expendiures rom waseul ones.
And ye he $1 ril lion in annual ax expendiure spending is rarely reviewed or eec-
iveness. Mos ax expendiures are permanen xures o he ax code, and some havelong oulased heir original purpose. Even ax expendiures ha have expiraion daes
are ypically renewed every year by Congress in he so-called “exenders” package wih
much less scruiny han is given o direc spending in he appropriaions process.
In CAP’s 2010 repor “Governmen Spending Undercover ,” Lily Bachelder and Eric
oder deailed a ramework or evaluaing ax expendiures. Tey suggesed our
undamenal quesions ha policymakers should consider in deciding which “IRS-
adminisered spending programs” o keep and which ones o cu:
•
Wha goals does he program poenially seek o achieve, i any?• Do hese goals remain worhy o axpayer suppor and i so, how much?• Wihin his budge consrain is he program srucured as eecively as i could be in
order o achieve is objecives?• I no, how could i be resrucured o maximize is eeciveness?
I Congress regularly sough answers o hese quesions, he ax expendiure budge
could be made much more ecien, reducing he deci by billions.
“Upside-down” subsidies should be made more fair and better targeted
Tough each ax expendiure should be evaluaed on is own meris, a large number o
ax expendiures share a common design faw ha reduces heir cos eeciveness. ax
expendiures ha aim o provide incenives hrough ax exclusions or deducions are
oen poorly argeed because o he so-called “upside-down” eec. Ta is, hey end o
provide he larges governmen subsidies o hose who need hem he leas while pro-
viding litle or no bene o hose who could use hem he mos. Tis happens because
deducions and exclusions are more valuable o hose in higher ax brackes.
6 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
ew o whom are in ax brackes higher han 28 percen in any even. Te wealhier amily
in our example above would sill be eniled o a large morgage ineres deducion, bu he
value o ha deducion would be limied o 28 percen o he $40,000 i pays in morgage
ineres, or $11,200.7 Ta’s sill a much bigger housing subsidy han he middle-income
amily receives, even measured per dollar o morgageineres. Ye he 28 percen proposal
would be much airer han exising law and raise signican revenue.8
O course, 28 is no a magic number. Congress could raise revenue even by simply
keeping he maximum value o iemized deducions a he curren 35 percen while
allowing he op ax rae o rever o he Clinon-era 39.6 percen, as i is scheduled
o do in 2013. Ta opion would keep he marginal incenive provided by iemized
deducions or op-bracke axpayers (including or morgage ineres and chariable
giving) exacly where hey are now.
Te more comprehensive way o improve he airness and cos eciency o ax expen-
diures is o ransorm hem ino fa credis. Credis are beter argeed because hey
give he same bene, per dollar o expense, o axpayers in all brackes. Te Cener or American Progress, in is recen long-erm balanced budge plan, “Budgeing or Growh
and Prosperiy ,” proposed o ransorm deducions or morgage ineres, chariable deduc-
ions, and reiremen savings ino fa credis over ime.
Te repor o he co-chairs o he presiden’s deci commission (known as “Bowles-
maching he botom-bracke ax rae under he co-chairs’ “illusraive” plan.9 Ta is, i you
pay $1,000 in morgage ineres, you could reduce your ax bill by $120, regardless o your
ax bracke. Tis would give he same ax bene o amilies in he lowes ax bracke as o
all oher amilies. Te Biparisan Policy Cener’s Deb Reducion ask Force would simi-larly replace iemized deducions wih 15 percen reundable ax credis. (A “reundable”
credi means i can also bene people wih no ederal income ax liabiliy.)
• Eliminaing ax expendiures beneing seniors living on Social Securiy, working
amilies, and people wih very low incomes would be misguided.
Sirred up by he pernicious myh ha many Americans have no “skin in he game”
because hey don’ pay axes, some have suggesed ha a cenral goal o ax code reorm
should be increasing he number o households ha have ederal income ax liabiliy in any
given year. (see box on page 8)
Presidenial candidae Jon Hunsman, or example, recenly proposed o sweep away all ax
expendiures on he heory ha “he ax burden is carried by oo ew.” Tis conuses he
desirable goal o broadening he income ax base wih he misguided noion ha everyone,
every year, should owe ederal income axes in addiion o he axes hey already pay.
10 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
use o axpayer dollars. For example, i i does no make sense or he governmen o pay
companies direcly o drill or explore or oil, hen he governmen shouldn’ be doing he
economic equivalen hrough he ax code.
Common-sense, fiscally responsible reforms to tax expenditures do not
have to wait for comprehensive tax reform
Deenders o waseul or inecien ax expendiures oen asser ha any changes should
only be considered in he conex o overall ax reorm. Invoking he prospec o a uure
ax code overhaul les everyone bene rom he saus quo while appearing pro-reorm.
Beneciaries sugges a willingness o give up heir ax breaks i everyone else does, and
poliicians can pose as ax reormers wihou having o ideniy whose ax breaks hey’d
close.26 Te resul is ha ough choices on ax expendiures are avoided, while direc gov-
ernmen spending programs ace he budge ax.
Comprehensive ax reorm is a desirable goal. Te ax code is badly in need o an overhaulo broaden he ax base. Bu sweeping ax reorm may no happen or many years. Te las
comprehensive ax code overhaul was a quarer-cenury ago, in he ax Reorm Ac o
1986. Ta legislaion was enaced only aer several years o wiss and urns and is now
viewed as a singularly rare accomplishmen.27
Policymakers oday universally agree on he need or “ax reorm,” bu here is enormous
disagreemen over such undamenal quesions as wheher ax reorm should raise, hold
consan, or lower revenues (o say nohing o which revenue benchmarks o use) and
wheher he overall ax burden should be made more or less progressive han i is now.28
Given hese realiies, here is no good reason o exemp ax expendiures rom ongoing
eors o reduce long-erm decis. Jus because a waseul subsidy is echnically a ax
break does no mean ha i can only be deal wih hrough overarching ax reorm. Tere
are many ways o reorm ax expendiures o reduce heir budge cos or eliminae he
leas jusiable ones. None o hese opions would preclude a laer, more undamenal ax
reorm. And eliminaing he mos waseul ax expendiures could make undamenal ax
reorm more likely by reducing he number o indusries wih vesed ineress o proec.
Many policymakers have over he las year come o recognize ha any credible and bal-
anced approach o addressing he Unied Saes’ long-erm scal challenges mus include
signican ax expendiure reorms. By adhering o he principles oulined in his issue
brie, policymakers can increase he airness and cos eciency o ax expendiures while
balancing our shor-erm economic challenges and long-erm scal challenges.
Seth Hanlon is Director of Fiscal Reform for the Doing What Works project at American Progress.
8/3/2019 Six Principles for Tax Expenditure Reform
11 Center or American Progress | Six Principles or Tax Expenditure Reorm: Common Sense Guidelines or Policymakers
Endnotes
1 “Examining Whether There is a Role or Tax Reorm in Comprehensive Decit Reduction and U.S. Fiscal Policy,” Senate Finance Committee Hearing, Sep-tember 13, 2011, available at http://nance.senate.gov/hearings/hearing/?id=a6c20c-5056-a032-521e-b4d151014e97.
2 “Discretionary Spending Under the Budget Control Act o 2011,” Congressional Budget Oce, Director’s Blog, (August 8, 2011), available at http://cbob-log.cbo.gov/?p=2597.
3 These gures do not take into account the “Pease” limitation on itemized deductions, which is currently repealed but is scheduled to go back into efectin 2013 under current law, or the separate calculation required under the Alternative Minimum Tax. It also assumes that both households itemize theirdeductions.
4 The skewed distribution o the mortgage interest deduction also results rom the act that upper-income households tend to have larger mortgagepayments, and interest is deductible on up to $1.1 million in mortgage debt. Households with incomes between $200,000 and $500,000 derive an aver-age benet o $3,572, while households with incomes between $50,000 and $75,000 derive an average benet o $364, according to estimates in: “TaxBenets o the Mortgage Interest Deduction, Basel ine: Current Law; Distribution o Federal Tax Change by Cash Income Level, 2011,” available at http://www.taxpolicycenter.org/numbers/displayatab.cm?Docid=3146&DocTypeID=1. These are roughly consistent with other estimates. See: Seth Hanlon,“Tax Expenditure o the Week: The Mortgage Interest Deduction,” Center or American Progress, January 26, 2011.
5 For more detailed discussions o the ineciency o upside-down tax expenditures, see: Lily L. Batchelder, Fred T. Goldberg, Jr., and Peter R. Orszag,“Reorming Tax Incentives into Uniorm Reundable Tax Credits,” (Washington: Brookings Institution, 2006), availabl e at http://www.brookings.edu/papers/2006/08taxes_orszag.aspx; Lily Batchelder and Eric Toder, “Government Spending Undercover” (Washington: Center or American Progress, 2010),available at http://www.americanprogress.org/issues/2010/04/pd/govspendingundercover.pd .
6 The proposal applies to itemized deductions as well as certain other tax expenditures that take the orm o “above-the-line” deductions and exclusions,including exclusions or employer-sponsored health insurance, municipal bond interest, and oreign-earned income and certain other business, healthcare, and education-related deductions.
7 Or 39.6 percent, as would be the case in 2013 under current law, under which the high-income Bush tax cuts are scheduled to expire.
8 I applied only to itemized deductions, it is estimated to raise $321 billion; applied to a broader set o deductions and exclusions (as President Obama hasproposed in the American Jobs Act), it would raise $405 billion.
9 National Commission on Fiscal Responsibility and Reorm, “The Moment o Truth” (2010), available at http://www.scalcommission.gov/news/moment-truth-report-national-commission-scal-responsibility-and-reorm.
10 Social Security benets are entirely exempt or households with “provisional income” below $25,000. Provisional income includes adjusted gross income plusone-hal o Social Security benets plus some otherwise tax-exempt income. See: Internal Revenue Service, “Social Security and Equivalent Railroad Retire-ment Benets” (2010), available at http://www.irs.gov/pub/irs-pd/p915.pd .
11 “Tax Benets o Partial Exclusion or Social Security Benets, Baseline: Current Law; Distribution o Federal Tax Change by Cash Income Level, 2011,” avail-able at http://www.taxpolicycenter.org/numbers/displayatab.cm?Docid=3140&DocTypeID=1.
12 Leonard Burman, Eric Toder, and Christopher Geissler, “How Big Are Total Individual Tax Expenditures, and Who Benets rom Them” (Washington: TaxPolicy Center, 2008), p. 10–13.
13 Figures are based on the Institute on Taxation and Economic Policy Tax Model, which includes all ederal, state, and local taxes (personal and corporateincome, payroll, property, sa les, excise, estate, etc.). See: Citizens or Tax Justice, “America’s Tax System Is Not as Progressive as You Think” (2011), availableat http://www.ctj.org/pd/taxday2011.pd . Even taking only ederal income taxes into account, the poorest 20 p ercent o households pay 4 percent o their incomes in taxes according to the Congressional Budget Oce. See: Congressional Budget O ce tables, available at http://cbo.gov/publications/collections/tax/2010/all_tables.pd .
14 President Ronald Reagan, “Letter to Members o the House o Representatives Urging Support or Tax Reorm Legislation,” December 9, 1985; PresidentGeorge W. Bush, Address to Congress, February 27, 2001.
15 Chuck Marr and Brian Highsmith, “Misconceptions and Realities About Who Pays Taxes” (Washington: Center on Budget and Policy Priorities, 2011); “TaxUnits with Zero or Negative Tax Liabilit y, 2004-2008,” available at http://www.taxpolicycenter.org/numbers/Content/PDF/T09-0412.pd; “Tax Units withZero or Negative Tax Liabili ty, 2012-2022,” available at http://www.taxpolicycenter.org/numbers/displayatab.cm?Docid=3055&DocTypeID=7.
16 Rachel Johnson and others, “Why Some Tax Units Pay No Income Tax” (Washington: Urban-Brookings Tax Policy Center, 2011).
17 “Who Doesn’t Pay Federal Taxes?”, available at http://www.taxpolicycenter.org/taxtopics/ederal-taxes-households.cm.
18 “Percentage o Tax Units that Pay No Individual I ncome Tax by Filing Status and Cash Income Level, Current Law, 2011-2013,” available at http://www.taxpolicycenter.org/numbers/displayatab.cm?Docid=3106&DocTypeID=1.
19 Johnson and others, “Why Some Tax Units Pay No Income Tax.” The Tax Policy Center’s denition o cash income can be ound here: “The Numbers,” avail-able at http://www.taxpolicycenter.org/numbers/displayatab.cm?DocID=574.
20 The sum o the personal exemption and standard deduction means that an individual’s rst $9,500 in income, and a couple’s rst $19,000, are not subjectto ederal income taxes (though they are subject to payroll taxes). See: Ro berton Williams, “Why Do People Pay No Federal Income Tax?”, TaxVox, July 27,2011, available at http://taxvox.taxpolicycenter.org/2011/07/27/why-do-people-pay-no-ederal-income-tax-2/.
21 President’s Economic Recovery Advisory Board, “The Report on Tax Reorm Options: Simplication, Compliance, and Corporate Taxation” (2010).
22 The carried interest loophole is a component o the larger tax expenditure that provides preerential tax rates on capital gains.
23 Richard Rubin and Andrew Zajac, “Corporate Jet Tax Gets Six Obama Mentions, Nicks Decit,” Bloomberg, June 30, 2011.
24 Oce o Management and Budget, “Living Within Our Means and Investing in the Future” (2011).
26 John M. Broder, “Oil Executives, Deending Tax Breaks, Say They’d Cede Them i Everyone Did,” The New York Times, May 12, 2011, available at http://www.nytimes.com/2011/05/13/business/13oil.html; Eric Toder, “Ryan’s Tax Plan is not 1986-Style Reorm,” TaxVox, April 12, 2011, available at http://taxvox.taxpolicycenter.org/2011/04/12/ryan%E2%80%99s-tax-plan-is-not-1986-style-reorm/.
27 Jefrey H. Birnbaum and Alan S. Murray, Showdown at Gucci Gulch: Lawmakers, Lobbyists, and the Unlikely Triumph of Tax Reform (1987).
28 For a discussion o the daunting obstacles to 1986-style tax reorm in the present context, see: Daniel N Shaviro, “1986-Style Tax Reorm: A Good IdeaWhose Time H as Passed,”Tax Notes, May 23, 2011.