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Sunday, August 5, 2012

Will Obama and Romney list the tax subsidies they will cut for lowered rates?

The calls for lower tax rates come along with vague calls for cutting tax expenditures or base broadening. I say vague because we rarely hear which specific deductions, exclusions or credits will be cut or scaled back. I say rarely because there are a few example. President Obama's FY2013 budget calls for cutting back on some preferential rules for oil, gas and coal producers.

Politics is a likely reason for the vagueness.  I suspect that most voters think the cuts would be for corporations  because they think that is where the bulk of benefits go.  But that is incorrect. Per data from the Joint Committee on Taxation, the largest tax break for individuals is the exclusion for employer-provided health insurance which costs $659.4 billion for 2010-2014. In contract, the most costly corporate tax expenditure is about 1/10 that size (it is for deferral of active income of controlled foreign corporations and costs $70.6 over the same five year period).

Here is an excerpt of a chart from the JCT report (JCX-15-11, page 25):

Clearly, to truly generate revenue to reduce both the corporate and individual rates, individual tax expenditures will need to be reduced.  There are additional good reasons to reduce or eliminate many of them, such as equity/fairness, neutrality, economic efficiency and simplicity.

What politicians need to be asking is - why do 70% of individuals want to subsidize home ownership for 30% of individuals who deduct mortgage interest?  Why do we spend roughly $90 billion per year to help middle and upper income individuals buy a more expensive home than they would otherwise purchase? Why do we subsidize borrowing to help someone purchase a vacation home?

But, how willing are politicians to do this when the questions are most likely to be misunderstood because the public has not been exposed to the data on the cost of tax expenditures and how inefficient and inequitable they are.

Yet, some of that may be starting. H.R. 6169 that passed in the House on August 2 refers to much of  the above as spending and subsidies.

What do you think?


Dave Spence said...

Hi Annette.

Love your blog. Very interesting chart too. Thanks for posting it. I agree that not enough people understand the numbers here.

One thing with which I disagree, however, is when the JCT refers to special-interest deductions as "tax expenditures." I don't think anything should be referrred to as an "expenditure" or even a "subsidy" unless it means a check is being written from the government to the taxpayer. So, unless something is truly a refundible credit (like the earned income tax credit), to me, it shouldn't be called a subsidy or expenditure. Such language presumes the money belongs to the government first. In other words, in my view, the government didn't earn the money and give it to the taxpayer, the taxpayer earned the money and was allowed to keep the money because (in theory) Congress believed it was somehow better for the country as a whole to do so--rather than disincentivizing the activity by taxing it. This is especially true, in my view, with so-called tax expenditures for which the taxpayer did not necessarily have the cash flow with which to pay the tax (for example, with the exclusion for employee benefits). These deductions or exclusions are really just accounting adjustments in how we calculate income.

Anyway, just my thoughts.

David Spence said...

By the way, I'm not saying any of these special-interest deductions are good policy--just objecting to the language in describing them.

Professor Nellen said...

David - thanks for the comments. You raise a good political and economic issue of debate. A common concern with "tax expenditure" is that it can make it sound like your income belongs to the government and they let you keep a portion tied to certain expenses you may have. But, most of the special deductions and credits have a similar effect to writing a check. For example, you can claim a $2,500 credit for your child attending college or the government can give your child a Pell grant - the effect on the budget and the family is the same.

Similarly, the government can write you a check monthly to help reduce your mortgage interest payment or the tax system can just lower your tax liability by that amount.

Also, not everything is deductible. So when the tax system selects a few items, it is favoring certain taxpayers and certain activities.

Good point about non-cash excluded compensation, such as employer-provided health insurance. However, this is a costly tax break. Even taxing 15% of someone's benefit would help provide funds to subsidize those who do not have employer-provided health insurance. If someone in a 20% tax bracket gets $10,000 of health insurance coverage from their employer, taxing $,1500 of that would cost the employee $300. Still a good deal for $10,000 of health insurance.

We now have both parties using the terms "tax expenditures," "spending in the tax law," "subsidies" and "loopholes" perhaps for both individuals and corporations. They need to do this because to lower rates, the base has to be broadened and the "tax expenditures" (special exclusions, deductions and credits that are not crucial for measuring taxable income) will have to be cut back or eliminated.

David Spence said...

I agree that the effect of direct subsidies compared to so-called "tax expenditures" is very nearly the same; but I believe there are some slight, yet important differences. Direct expenditures are generally outside the control and management of the taxpayer, and they take up additional resources for administration when compared to the mere cost of tax enforcement.

I know the "tax expenditure" and similar language has become common parlance, and it is really the parlance to which I object. It has a political connotation. I feel the same way about the term "loophole," which I believe is over-used and often misused. The connotation is that the taxpayer is taking advantage of an unintentional or unforeseen effect of some obscure or arcane language in the law. Loopholes do sometimes exist; but I don't think congressionally intended, statutory tax benefits should be referred to as loopholes (though they often are). An example of the comparison (from an area of the law with which I'm familiar) would be a sale to an intentionally defective grantor trust, which one could legitimately argue is a loophole; whereas a GRAT, which has very nearly the same financial mechanism and effect, is not a loophole in my view because it is a tax benefit intentionally built into the statute.

Anyway, as you can probably tell, I very much enjoy discussions of tax policy and appreciate that you bring it to the forefront. I only wish the demands of career would allow me more active involvement in the debate.

Professor Nellen said...

Yes - "loophole" is often misused. I think it gets used when the speaker wants to get rid of something. Then it becomes a loophole or corporate welfare (unless it involves individuals).

Congressman Paul Ryan's FY2013 budget plan - The Path to Prosperity, uses the term "loophole". "Reforms broken tax code to make it simple, fair, and competitive; clears out special interest loopholes and lowers everybody’s tax rates to promote growth" He does not specify the "loopholes." He does use the term in the context of individual tax reform (page 15;