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Six Principles for Tax Expenditure Reform

Six Principles for Tax Expenditure Reform

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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.
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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Published by: Center for American Progress on Oct 20, 2011
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1Center or American Progress | Six Principles or Tax Expenditure Reorm: 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 Inernal Revenue Code. Called ax expendiures, hese provisions have gen-erally received ar less scruiny han oher orms o governmen spending, parly becausehey are hidden in he ax code. A long las, policymakers ocused on deci reducionare discovering ha ax expendiures can no longer be ignored i he Unied Saes is oachieve scal susainabiliy over he long erm.“ax expendiure” is he echnical erm or special ax breaks ha come in he ormo exclusions, deducions, credis, preerenial raes, or deerrals o ax liabiliy. Tey are called expendiures because hey are uncionally he same hing as direc govern-men spending, as economiss have long recognized. I he governmen subsidizes anaciviy by spending money on i direcly, or by carving ou a special ax break or i,he eec is he same.Individual and corporae income ax expendiures,measured by he size o he revenue loss o he ederalgovernmen, add up o abou $1.1 rillion. Ta’s abouhree-quarers o he amoun he ederal governmen will acually collec in income axes his year. Andi’s abou wice he budge or all ederal “domesicdiscreionary” spending, which unds criical publicinvesmens and services including ransporaion andinrasrucure, public healh and medical research, edu-caion, housing, environmenal proecion, ood anddrug saey, law enorcemen, and veerans 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.
Defenseand securityMedicareand MedicaidSocialSecurityOthermandatoryprograms“Domestic”discretionaryprogramsInterest onthe debtTax expenditures,combined total
In billions
2Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
Domesic discreionary spending has been hi hard by recen budge cus. Congress in April chopped he budge auhoriy or his caegory 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 addiional $1 rillionrom discreionary spending over he nex 10 years, wih he heavies cus in he nonde-ense caegory.Under he so-called super commitee’s mandae, he nex round o deci reducion cancome rom any source. And so i is appropriae ha ax expendiures be on he able inhe super commitee’s deliberaions and in uure budge debaes. I’s jus as imporanha policymakers ge i righ when i comes o achieving deci reducion hrough ax expendiure reorm. Tis issue brie oers six principles inended o guide hem:
ax expendiures are spending.
Like all orms o spending, ax expendiures should be assessed or cos eeciveness.
“Upside-down” subsidies should be made more air and beter argeed.
Eliminaing ax expendiures beneing seniors living on Social Securiy, workingamilies, and people wih very low incomes would be misguided.
Te ax code should be scrubbed o ineecive business subsidies.
Common-sense, scally responsible reorms o ax expendiures do no have o waior comprehensive ax reorm.
 Tax expenditures are spending
Proposals o curail ax expendiures, including Presiden Obama’s, are oen widely repored as “ax increases.” Bu economiss across he ideological specrum have longrecognized ha ax expendiures are really jus governmen spending ha happens o bedelivered hrough he ax code.I he morgage ineres deducion, or example, were adminisered by he Deparmeno Housing and Urban Developmen, and i operaed by sending homeowners checksha mach a porion o heir ineres paymens, i would be considered a spending pro-gram. Bu because he morgage ineres deducion is acually adminisered by he IRSand subsidizes homeownership hrough argeed ax benes, i is accouned or in heederal budge as a ax reducion.Te disincion is mainly one o orm, no subsance, and i shouldn’ guide policymaking.
3Center or American Progress | Six Principles or Tax Expenditure Reorm: Common-Sense Guidelines or Policymakers
Tis poin was underscored by a panel o prominen economiss and ax expers esiying beore he Senae Finance Commitee on Sepember 13. As ormer Federal Reserve BoardChairman Alan Greenspan old he senaors:
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, Marin Feldsein, likewise esied ha when ax expendiures are reduced, “he economic eec is he same as any oher reduc-ion in governmen oulays.” And Edward Kleinbard, ormer direcor o Congress’s JoinCommitee on axaion, explained ha deliberae Congressional subsidy programs bakedino he ax code…are a orm o governmen spending, no ax reducions.
 Once you recognize ha ax expendiures are simply a hidden orm o spending, i makes nosense o slash ederal programs and enilemens while leaving ax expendiures o he able.Tis is especially rue because he Budge Conrol Ac, enaced in Augus, subjecs ohercrucially imporan ederal programs o signican cus in he coming years. Caps imposed by he Budge Conrol Ac will cu discreionary spending by nearly $1 rillion over henex 10 years. Te resul is ha discreionary spending would decline rom 9 percen o gross domesic produc, or GDP, o abou 6.2 percen by 2021, which, as CongressionalBudge Oce Direcor Douglas Elmendor noes, is “ well below he 8.7 percen averageover he pas 40 years.
Wih discreionary spending already subjec o hese caps, uuredeci reducion mus be balanced across he ederal budge, including on he revenue sideo he ledger. o be sure, he bes and mos sraighorward way o raise signican revenuemigh simply be o allow he Bush ax rae cus or op income earners expire on schedulea he end o 2012. Bu even hose who are adaman abou keeping all ax raes where hey are now should be open o reducing hidden ax code spending.Ta doesn’ mean ax expendiure reorms need o happen now. Te op prioriy oday should be job creaion, no deci reducion. And overly severe cus o ax expendi-ures, like all scal conracion, should be avoided in he near erm while he economy sruggles o recover. Bu lawmakers should pursue an approach ha gradually reorms orphases ou ineecive ax expendiures.

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