A good explanation of removing spending from the tax code

There is much debate among conservatives about what exactly constitutes a tax increase. Obviously, raising rates qualifies.

But while some people seem to think it’s anything that causes anyone anywhere to pay any more in taxes, there are others of us who recognize that most tax credits and deductions are really government spending by another means. In fact, it’s a more pernicious form of government spending because it favors certain activities and people over others (as opposed to a broader policies that apply to all income and earners) yet is largely hidden and shielded from the annual budgeting process.

I could go on — and have done so in the past — but former Reagan economic adviser Martin Feldstein, in a new piece for the Weekly Standard, does a very good job of making the case:

When the government gives a tax credit to homeowners who buy solar energy panels, it’s just like giving them a cash subsidy to buy those panels. But it’s recorded as a reduction in taxes rather than as an increase in outlays.

Similarly, when the president calls for an increase in the child care credit, that’s also treated as a tax cut rather than the rise in spending that it actually is.

According to calculations of the Treasury Department that are hidden deep in the government’s annual budget, there are hundreds of billions of dollars of spending every year that are recorded as tax reductions. The biggest of these “tax expenditures,” as they are called, is the exclusion of employer health insurance premiums from the taxable income of employees. That exclusion resulted in a tax reduction of $160 billion in 2010 and is projected to be $1.4 trillion between 2010 and 2016. That’s a $1.4 trillion subsidy to health insurance that is disguised as a tax reduction. …

Limiting tax expenditures should have bipartisan appeal. Republicans should welcome limits on tax expenditures as a way to cut hidden government spending. Democrats should accept it as a way to raise the revenue that they insist must be part of any deficit reduction plan. … it is also a natural way to achieve an automatic “failsafe” mechanism to make sure that deficits decline as promised.

Although limiting the use of tax expenditures would produce additional tax revenue, it is very different from other possible revenue increases. It doesn’t raise marginal tax rates, doesn’t discourage work or entrepreneurship, and doesn’t tax saving and risk taking. It is really a reduction in government spending, not a tax increase. And deep enough cuts in tax expenditures would actually allow reductions in personal tax rates as well as in budget deficits.

Of course, such a change would discourage — or stop encouraging — certain activities. But why would those of us who favor limited government be opposed to that? Of course, there are some incentives in the tax code that can be justified, just as the proper level of federal appropriations is not zero. And deductions for things like health insurance and mortgage interest would have to be handled very carefully and gradually so as not to disrupt huge sectors of the economy, even if there is ample reason to think that removing these distortions — again, carefully and gradually — could actually make those sectors stronger in the long run.

In any case, Feldstein supports not eliminating itemized deductions but capping them at 2 percent of a taxpayer’s adjusted gross income. That would allow for a certain amount of incentives without overly distorting individuals’ decision-making.

Feldstein writes that he and two co-researchers studied such a policy and

found that if a 2 percent cap were in effect in 2011 it would result in additional tax revenue of $278 billion. That’s the extra revenue for just a single year. In a decade it could produce more than $3 trillion of additional revenue, enough to achieve a substantial reduction in the national debt while also permitting cuts in personal tax rates.

The tax expenditure cap could also play a key role in a failsafe plan. The tax expenditure cap could initially be set at a larger percentage of adjusted gross income, thus producing less revenue, but could be scheduled to become a tighter cap if additional revenue is needed. An initial cap of 5 percent of adjusted gross income would produce revenue of $110 billion in 2011. If the other outlay cuts and the rise in revenue resulting from economic growth brought the deficit down along an agreed path over the coming decade, the 5 percent cap could remain. But if deficits remained unacceptably high, the cap could be reduced to 3 percent or 2 percent.

Ideally, as I’ve stated before, the removal of deductions should be balanced by lowering marginal tax rates. And in the long term, that’s still true. But if such a policy represented the $1 of new tax revenues for $3 in spending cuts that bipartisan panels have recommended for closing budget deficits and paying down the national debt, I could live with that deal.

– By Kyle Wingfield

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92 comments Add your comment

Logical Dude

May 24th, 2011
12:31 pm

Now that’s just too complicated! ;)

It’s just easier to let the “Bush Tax Cuts” expire.

And THEN handle the complicated stuff. . . carefully and gradually. . .

that's goofy

May 24th, 2011
12:50 pm

would this include ending tax credits… or subsidies for oil, agriculture and other industries? Or is this just another plan to jam the tax payer?

What??

May 24th, 2011
12:52 pm

Wait..I’m confused..so giving a tax credit is essentially government spending…wouldn’t that make a tax reduction without corresponding drops in spending, additional spending.

I’m so confused.

Bryan G.

May 24th, 2011
1:00 pm

Logical Dude – I think we should let all the Bush tax cuts expire. When the lowest rate goes from 10% back to 15%, then we’ll see what people think about “paying their fair share.”

Kyle Wingfield

May 24th, 2011
1:02 pm

Logical Dude: All the deductions and credits and other loopholes in the tax code are one of the main reasons that raising rates, aside from hurting the economy, won’t increase revenues nearly as much as estimated. From a purely practical standpoint, raising rates in isolation simply means that those who are already paying accountants to minimize their tax payments will simply continue doing so.

that’s goofy: As far as I’m concerned, cutting or ending tax expenditures would apply to corporate as well as individual income taxes.

j

May 24th, 2011
1:36 pm

Lets do away with corporate AND Social welfare… End loopholes for business, and for the poor! If you pay 100 dollars in fed taxes, and file taxes with X amount of kids, you only get 100 back at most, not 2000!

Hillbilly Deluxe

May 24th, 2011
1:38 pm

It’s like the game of finding the pea under one of the three shells. The catch is, the pea isn’t under any of them.

We need to do away with all the breaks, credits and deductions. This of course, can’t be done cold turkey, without further imploding the economy. It’ll take a 20-30 year phase in, so might as well go ahead and get started.

And while we’re at it, why don’t we look at taxing all forms of income at the same rate?

jt

May 24th, 2011
1:40 pm

Republicans and Democrats agree……………………..the Federal government NEEDS more money.
.
How else will the Feds plan your retirement, pay your medical bills and protect you frightened, dim-witted R&D voting sheep from mooooslims and marijuana cigarettes.?
.
Just shut-up and get your wallets out.

Jefferson

May 24th, 2011
1:55 pm

This double speak is part of the problem.

Linda

May 24th, 2011
1:57 pm

Burn the entire tax code. Implement the fair tax. Close the IRS.

Hillbilly Deluxe

May 24th, 2011
2:02 pm

Wouldn’t the Fair Tax, with all the prebates and everything, require a bureaucracy just as big as the IRS?

saywhat?

May 24th, 2011
2:10 pm

“Wouldn’t the Fair Tax, with all the prebates and everything, require a bureaucracy just as big as the IRS?”

Of course not, silly. Magic conservative fairies will run the program for free, as well as prevent the inevitable black markets that will arise. Just read the book!

Linda

May 24th, 2011
2:16 pm

When discussing taxes, it’s too simple to say that taxpayers pay taxes.
The government’s only consumer is the economy.
The government’s worst enemy is itself.

Hillbilly Deluxe

May 24th, 2011
2:16 pm

saywhat?

I’m of the opinion that the Fair Tax would be one of the easist taxes to evade. Maybe that’s part of its appeal?

Scooter (The Original)

May 24th, 2011
2:23 pm

The FairTax would reduce the collection points of taxes to retail businesses and service providers. The current tax system supports black markets and doesn’t collect taxes from people who don’t report income. That said, the FairTax would expand the tax base and reduce the collection points. It amazes me how many people refuse to open their minds to this proposal for political reasons.

Linda

May 24th, 2011
2:27 pm

The current tax code penalizes work. Does anyone else see a problem with that?

How much do individuals & corporations spend each year to people figuring their taxes & finding loopholes: bookkeepers, accountants, financial planners, lawyers, etc.?

Linda

May 24th, 2011
2:34 pm

The Fair Tax encourages savings & investments, which will improve the economy with more innovations in products & services, more jobs created & more wealth, especially to the middle class.

Kyle Wingfield

May 24th, 2011
2:34 pm

jt: Just curious, since you don’t seem to like this idea…which part of tax-code spending do you like best? The part where we subsidize people’s purchases of houses, solar panels, certain vehicles, etc.? Or the part where you have to do what the government wants you to do — buy a house, a solar panel, a certain kind of vehicle, etc. — in order to keep more of your money?

Linda

May 24th, 2011
2:45 pm

Why do we have a tax code (& a welfare system) that encourages having children but does not encourage marriage?

Bart Abel

May 24th, 2011
2:57 pm

Feldstein’s logic is convenient and inconsistent.

He’s essentially arguing that using the tax code for social engineering via deductions and credits is equivalent to government spending, but using the tax code for social engineering via tax rates isn’t. It’s okay, he asserts, to reduce tax rates on income from inheritances and investments to encourage “saving and risk taking”, yet simultaneously increasing revenue on earned income has no impact on the motivation to work harder?

I’m sorry, but Feldstein can’t have it both ways. This is flowery language restating the typical right-wing argument that we need to tax work at higher levels while taxing inheritances and investment income at lower levels such that the “risk takers” will take care of us. It’s trickle-down economics in new packaging.

In actuality, risk takers create jobs and workers create returns on the investments that risk takers make. One can’t succeed without the other, and therefore, income from both should be taxed at precisely the same rates. In other words, our capital gains, dividends, and inheritances should be taxed at the same rates as our paychecks. The result being lower income tax rates for all, more money in our pockets, more spending, bigger returns on investments, and more jobs.

What??

May 24th, 2011
3:05 pm

Linda-
Why do we have a tax code (& a welfare system) that encourages having children but does not encourage marriage?

So the double the exemption amount and the double every thing else in the tax code doesn’t promote marriage??

You do realize that a married couple and a single person with one kid get the same personal exemption right, except the married couples standard deduction is higher and thus less money is actually taxable.

Kyle Wingfield

May 24th, 2011
3:08 pm

Bart: Sorry, but the “social engineering” is taxing estates in the first place, not in tinkering with the rate. I don’t see how you could possibly argue otherwise.

Btw, the same is true of a progressive tax code. Deciding that some people should pay higher rates of tax than others is purely an attempt at “social engineering.” As with the estate tax, you might *like* that kind of engineering, but to argue that it’s not engineering is ridiculous.

What??

May 24th, 2011
3:10 pm

Social engineering is a discipline in political science that refers to efforts to influence popular attitudes and social behaviors on a large scale, whether by governments or private groups.

I’m confused as to how an estate tax falls into this category.what action is it trying to influence…not dying????

Im even more confused by how a progressive tax systems falls into that category as well. Only because for that to actually be social engineering, the higher brackets would actually discourage people to make that much money. But that doesn’t seem to be the case in the real world.

Hillbilly Deluxe

May 24th, 2011
3:14 pm

I’m against the Estate tax on principle. The money was already taxed once, when it was made. It only applies to individuals, as well. A corporation doesn’t die just because the CEO does. In theory, anyway, a corporation is immortal.

What??

May 24th, 2011
3:17 pm

The money was taxed to the person who died, not to the person that inheritied it. By that logic, since taxes were taking out of your paycheck, then the sales tax should be abolished because the money you are using was already taxed.

Hillbilly Deluxe

May 24th, 2011
3:21 pm

The only people the Estate Tax affects are people trying to pass on a family farm, or a small family run business. People will real money don’t pay it; they have the means and the know-how to evade it. Think the Bushes, the Kennedys, the Rockefellers, etc, ever pay any inheritance tax?

Kyle Wingfield

May 24th, 2011
3:22 pm

What??: Your definition from Wikipedia notwithstanding, I think it’s pretty commonly accepted that social engineering in government refers to those policies that try to re-structure or -engineer society to one’s liking. In these cases, through the tax code.

Linda

May 24th, 2011
3:26 pm

What@3:05, The marriage tax penalty has come & gone over the years. It would have expired 1/1/11 had the Bush tax cuts not been extended & is due to expire again 1/1/13. It does not apply to higher income earners.

What??

May 24th, 2011
3:34 pm

Kyle-

Then what does a progressive tax system engineer.
I agree with you on the homeowners deductions(buy a house) child tax credit(kids), but as a whole, what exactly does the tax system itself engineer.

Linda-
I actually wasn’t referring to the marriage tax penalty…but I understand where you were going with it.

Your questions was how does a tax code incentivize marriage more or less. My statement was the fact that they receive double the exemptions. If a single parent files head of household, their deduction is 7500, if married, the couples deductions is 10k. The tax rates are somewhat disproportianate in comparison to a married couple. Usually because you have to disproportinate incomes.

jconservative

May 24th, 2011
3:35 pm

Kyle you gonna git run outta town by Grover and his boys!

Whatever name is given to whatever plan we end up with, the bottom line is we got into this “mess” by cutting revenue and increasing spending for 28 of the last 31 budgets. We will only get out of this “mess” by reversing that formula by increasing revenue and cutting spending.

As soon as those married to a certain economic “theology” get through playing make believe, then the rest of us can get together and resolve the “mess”.

Kyle, if you need a place to hide out, let me know. There’s this barn out back……

Gordon

May 24th, 2011
3:44 pm

It takes power away from politicians. That is why it won’t happen.

Kyle Wingfield

May 24th, 2011
3:44 pm

What?? @ 3:34: Redistribution of wealth, of course.

jconservative: Thanks, but I think I’ll be OK. :-)

MiltonMan: More like a modified flat tax, I’d say, assuming we could also get to a flat rate…

1961_Boomer

May 24th, 2011
3:44 pm

This is yet a different from of social engineering!

This would severely punish the middle class, where home mortgage deductions and child/child care tax credits lower the rate paid by those making $50,000-$10000 by about 10%. Under a plan like this, a family making $85k ($65k after deductions) would go from paying about $8000 a year in taxes to nearly $18,000. Their monthly federal income tax burden would exceed their mortgage, and this would cut their discretionary spending by about 30%. The consequences for the economy and for the mortgage industry are obvious.

But what about the poor? Well, under this plan a significant number of poor would actually start paying taxes! Gone would be the tax credits, deductions, and welfare based on Adjusted Gross Income. Someone making $40k could no longer get $10k+ in deductions that enabled them to qualify for a wide range of refundable tax credits. That person making $40k would suddenly find themselves with a $6k taxes owed and $800 in deductions… The government would take an extra $5200 bite from their yearly income AND they would lose a slew of bennies.

Even someone making $22000 a year would have a maximum of $400 in deductions, and see their tax burden rise from essentially nothing to about $1800 per year.

And lets remember that, under Paul Ryan’s plan, BOTH of the above groups would need to start saving anywhere from $2400 and $6000 a year… depending on age… to fund a gap between their Medicare voucher and the actual cost of health insurance in old age.

Feldstein likes to frame up the “low hanging fruit” type of deductions without examining ALL of the social engineering built into the tax code. If you don’t attack ALL of the social engineering .. .and that INCLUDES food stamps, Earned income child credits, personal deductions, home mortgage deductions, education expenses, etc… then all you have done is add some more social engineering to the mix.

BTW, I am not advocating either way. I think that if we got rid of ALL deductions and exemptions, and reduced the Federal Income tax rates by 50%, we would be a lot better off. That other 50% is , literally, the “politics” that is built into the tax code.

MiltonMan

May 24th, 2011
3:44 pm

Kyle, this sounds more like a modified FairTax system that would get rid of certain deductions but not all

Kyle Wingfield

May 24th, 2011
3:49 pm

And I have no idea how my comment suddenly was posted above the comment by MiltonMan to which I responding…WordPress weirdness…

Kyle Wingfield

May 24th, 2011
3:50 pm

1961_Boomer: If I may presume to speak for Feldstein, I don’t think he would stop at the examples he mentioned in his article.

Bart Abel

May 24th, 2011
3:56 pm

Progressive income taxes and taxing inheritances are social engineering? That’s a first for me.

People who receive most of their income from inheritances do not benefit from government services, such as national defense and infrastructure, any less than those who earn most of their money. So inheritances should be taxed at the same rates as our paychecks. That’s not social engineering. That’s basic fairness.

On the issue of progressive tax rates, Kyle, I’m afraid that you’re projecting false arguments onto those who support it. I’m sure there are exceptions, but the best arguments in favor of progressive taxes have everything to do with pragmatism and fairness and less to do with changing behavior.

Again, favoring one source of income over another source of income to encourage a particular behavior is, in fact, social engineering. And again, Feldstein is proposing eliminating “spending” where it mostly benefits working people while arguing in favor of “spending” where it primarily benefits those whose incomes come mostly from other sources.

Hillbilly Deluxe

May 24th, 2011
3:56 pm

And I have no idea how my comment suddenly was posted above the comment by MiltonMan to which I responding…WordPress weirdness…

It’s been happening on ALL the AJC blogs for several days. It’s extremely annoying.

Jack

May 24th, 2011
4:00 pm

End the EITC. It’s abused and the IRS doesn’t have the personnel to police it.

1961_Boomer

May 24th, 2011
4:01 pm

Kyle, but while he would not stop at the examples mentioned, he fails to extend the argument to the obvious and controversial consequences of this change…. that most people would have to pay a lot more in taxes,and most would lose their refundable credits. He also does not extend this to BUSINESS, and business taxes.

The real reason, though, while this will never happen is that this would essentially kill the ability for politicians to buy votes, and would kill the ability of lobbyists to buy politicians.

What??

May 24th, 2011
4:02 pm

Kyle-
Redistribution of wealth….

WHAT!!!…
1. Besides the EITC(signed in by Reagan), there is really no take from you and give to him in the tax code
2. That would be totally independent of it being progressive, regressive or flat anyway which was what my question was about..
3. Using that logic, if the tax code is a big redistribution of wealth, wouldn’t all tax codes be the same prinicple(flat, fair.etc.).
4 Could someone please explain to me where this redistribution of wealth thing came from anyway. You make it seem as though the is a hand to hand transfer of money from you to someone else.

Kyle Wingfield

May 24th, 2011
4:07 pm

Bart: We don’t have a separate tax for inheritances, we have a separate tax for estates. There is a huge difference. Estates can and often do represent going business concerns that are broken up for no good reason other than to satisfy the taxman and some people’s notion of societal equality.

Even if we didn’t have an estate tax, heirs would pay income tax on the money they inherited.

Jefferson

May 24th, 2011
4:13 pm

Fair and simple would be progressive rate based on all income – gross amount, no deductions, no exemptions. There you go, the more you make, the more you keep.

Kyle Wingfield

May 24th, 2011
4:13 pm

What??: While revenues from a flat tax could certainly be used for redistributing wealth, a progressive code certainly lends itself to being more redistributive because it aims to take a different proportion of money from one group than from another.

As for “where this redistribution of wealth thing came from anyway”…something about “From each according to his ability…”

Now, would you care to get back to the original topic of tax credits and deductions?

What??

May 24th, 2011
4:17 pm

As a CPA, I find this statment to be incorect
“Even if we didn’t have an estate tax, heirs would pay income tax on the money they inherited”

The majority of the inheritance is non taxable.
1. Certain amounts have to be met to even qualify it as taxable
2. At death, the basis is dollar for dollar, so in the case of stock, you would only get taxed at the capital gains rate…if it was taxable at all.
3. Last study I read, most estates have enough liquid assets to cover the tax debt. Most aren’t broken up to settle the debt. The IRS did a study on it a few years ago.

What??

May 24th, 2011
4:18 pm

Kyle-

So your point is moot. If a flat tax is redistributive as well, what are you arguing for?

Linda

May 24th, 2011
4:20 pm

Bart@3:56, Assuming you work & pay your taxes, you are able to keep your net income to invest in a home, cars, antiques, the stock market, etc. Your net income & what you buy or invest in is yours. When you die, you think your children should have to pay taxes on it? That means your accumulation of wealth/possessions are only yours until you expire. The government decides whose children & grandchildren you worked & saved for.

Bart Abel

May 24th, 2011
4:22 pm

Society equality? I’m not sure what your mean by that Kyle. However, if taxing all sources of income at the same rates, including income from an estate…which was inherited, falls under some people’s notion of societal equality, then so be it.

By the way, going concerns are a tiny fraction of all inheritances. I support making exceptions to the tax code for exceptions. However, I don’t support designing a tax code entirely around the exceptions.

Linda

May 24th, 2011
4:26 pm

Bart@4:26, What did you children do to you?

Bart Abel

May 24th, 2011
4:26 pm

Yes Linda, when I die, I want my children to pay taxes on their inheritances at the same rate that their neighbors pay on income that they earn from their jobs. My children will be able to keep the net inheritance income to invest in a home, cars, antiques, the stock market, etc.