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Here's why closing tax 'loopholes' will be harder than it sounds

  • Like everything involving the U.S. tax code, the task of eliminating those tax loopholes will be far from simple.
  • The problem is each "loophole" becomes a windfall, usually fiercely defended by millions of businesses and households.
  • For individuals, the biggest break is the tax treatment of health insurance benefits paid by employers, which can represent a sizable portion of a given worker's overall compensation.
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It sounds like a simple enough idea.

To pay for proposed big tax cuts for companies and households, all you have to do is get rid of many of the deductions, exemptions, loopholes and other tax breaks that cost the Treasury billions in uncollected revenues.

But like anything involving the U.S. tax code, the task of eliminating those loopholes is far from simple. The reason is that each of those "loopholes" is also a tax windfall, usually fiercely defended by lobbyists and members of Congress representing millions of their constituent businesses and households.

While corporate "loopholes" may draw the biggest ire from voters, individual taxpayers are by far the biggest beneficiaries of federal tax breaks. Some taxpayers may not even be aware of the breaks they're getting.

The costliest loophole, for example, is the tax treatment of health insurance benefits paid by employers, which can represent a sizable portion of a given worker's overall compensation. But because that benefit is not taxed as income, the Treasury loses out on billions of dollars every year.

For the fiscal year that ended last week, that provision alone cost the government some $221 billion, more than the deduction for state and local taxes, ($91 billion), the mortgage interest deduction ($69 billion) and charitable deductions ($48 billion.)

But the White House and congressional tax reform writers have said that closing loopholes is a "key principle" of the proposed overhaul.

That task will likely post the thorniest challenge to architects of the initial nine-page "framework" unveiled last week by the Trump administration that was drawn up by Treasury Secretary Steven Mnuchin, Trump economic advisor Gary Cohn, House Speaker Paul Ryan, House Ways and Means Chairman Kevin Brady, Senate Majority Leader Mitch McConnell and Senate Finance Chairman Orrin Hatch.

The document promises to cut tax rates and "eliminate most tax deductions"— but stops short of spelling out which ones would be repealed.

"[If] I'm giving you a subsidy for buying this thing but then I have to charge you a higher tax rate because I gave you a subsidy, then all that complexity isn't really putting more money in your pocket," the new chairman of the White House Council of Economic Advisers, Kevin Hassett, told CNBC last week.

For small businesses and large corporations, that complexity has been built into the tax code after decades of lobbying on behalf of industries, regions and specific companies. Many of these represent relatively small costs to the Treasury, but collectively, they amount to hundreds of billions of lost revenue.

The largest, by far, is the tax break corporations get on foreign income, worth an estimated $500 billion from 2016 through 2020.

And even before the architects of tax reform began the difficult task of closing favored tax breaks, they opened up a new one in the GOP framework. The provision, which allows companies to write off the cost of new equipment over five years, already costs the Treasury tens of billions a year.

The framework proposed accelerating that schedule, allowing companies to write off the full amount immediately.