1Center 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 HanlonOctober 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 becausehey are hidden in he ax code. A long las, policymakers ocused on deci reducionare discovering ha ax expendiures can no longer be ignored i he Unied Saes is oachieve scal susainabiliy over he long erm.“ax expendiure” is he echnical erm or special ax breaks ha come in he ormo 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 anaciviy 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 ederalgovernmen, add up o abou $1.1 rillion. Ta’s abouhree-quarers o he amoun he ederal governmen will acually collec in income axes his year. Andi’s abou wice he budge or all ederal “domesicdiscreionary” spending, which unds criical publicinvesmens and services including ransporaion andinrasrucure, public healh and medical research, edu-caion, housing, environmenal proecion, ood anddrug 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.
020040060080010001200
Defenseand securityMedicareand MedicaidSocialSecurityOthermandatoryprograms“Domestic”discretionaryprogramsInterest onthe debtTax expenditures,combined total
In billions
2Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
Domesic discreionary spending has been hi hard by recen budge cus. Congress in April chopped he budge auhoriy or his caegory by $39 billion in scal year 2011, a 7percen cu rom las year’s levels. And in he recen agreemen ha ended his summer’sdeb limi crisis, Presiden Barack Obama and Congress cu nearly an addiional $1 rillionrom discreionary spending over he nex 10 years, wih he heavies cus in he nonde-ense caegory.Under he so-called super commitee’s mandae, he nex round o deci reducion cancome rom any source. And so i is appropriae ha ax expendiures be on he able inhe super commitee’s deliberaions and in uure budge debaes. I’s jus as imporanha policymakers ge i righ when i comes o achieving deci reducion hrough ax expendiure reorm. Tis issue brie oers six principles inended o guide hem:
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ax expendiures are spending.
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Like all orms o spending, ax expendiures should be assessed or cos eeciveness.
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“Upside-down” subsidies should be made more air and beter argeed.
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Eliminaing ax expendiures beneing seniors living on Social Securiy, workingamilies, and people wih very low incomes would be misguided.
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Te ax code should be scrubbed o ineecive business subsidies.
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Common-sense, scally responsible reorms o ax expendiures do no have o waior comprehensive ax reorm.
Tax expenditures are spending
Proposals o curail ax expendiures, including Presiden Obama’s, are oen widely repored as “ax increases.” Bu economiss across he ideological specrum have longrecognized ha ax expendiures are really jus governmen spending ha happens o bedelivered hrough he ax code.I he morgage ineres deducion, or example, were adminisered by he Deparmeno Housing and Urban Developmen, and i operaed by sending homeowners checksha mach a porion o heir ineres paymens, i would be considered a spending pro-gram. Bu because he morgage ineres deducion is acually adminisered by he IRSand subsidizes homeownership hrough argeed ax benes, i is accouned or in heederal budge as a ax reducion.Te disincion is mainly one o orm, no subsance, and i shouldn’ guide policymaking.
3Center 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 BoardChairman 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 assubsidies 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 JoinCommitee on axaion, explained ha “deliberae Congressional subsidy programs bakedino he ax code…are a orm o governmen spending, no ax reducions.”
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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 ohercrucially 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 henex 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 CongressionalBudge Oce Direcor Douglas Elmendor noes, is “ well below he 8.7 percen averageover he pas 40 years.”
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Wih discreionary spending already subjec o hese caps, uuredeci 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 revenuemigh simply be o allow he Bush ax rae cus or op income earners expire on schedulea 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 orphases ou ineecive ax expendiures.
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Six Principles for Tax Expenditure Reform
Fixing the excessive and expensive system of tax breaks, credits, and loopholes is key to any deficit reduction plan. Seth Hanlon suggests six principles to guide Congress’s work in this area.
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