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