The two political parties and their presidential standard bearers are moving inexorably toward an acrimonious public debate next month over how to pay for tax reform, which will be a major issue during the next session of Congress no matter who wins the White House or controls Congress after November.
They agree on only one principle: Lowering income tax rates, whether for individuals or corporations, will require eliminating some tax deductions and exemptions, the so-called tax expenditures (or in common parlance, loopholes) that reduce government tax collections by an estimated $1.1 trillion a year.
But the two sides are still bitterly divided over whether the goal should be fiscal neutrality or raising additional revenue for the government. Neither side wants to get too specific ahead of the election or the lame duck session Congress, which will have to deal with the so-called fiscal cliff of tax increases and budget cuts that could throw the economy into recession next year.
Assuming that the resolution of those issues will be some variation of kicking the can down the road – even if only for a few months – then tax reform will take center stage. Reform is key to any serious plan for reducing the nation’s budget deficit. And reducing tax expenditures is key to reforming the tax code.
COMPLICATED AND CONVOLUTED LOOPHOLES
The economists’ rap against the dozens of loopholes in the tax code is straightforward, non-controversial and generally ignored by the taxpayers and corporations whom they benefit. They’re unfair, they’re inefficient and the benefits are distributed unevenly.
They’re unfair because they treat similar taxpayers differently. Why do homeowners get their housing costs subsidized through the mortgage interest deduction while renters do not?
They’re inefficient because they influence economic behavior in ways that may be detrimental to the economy as a whole. Excluding health insurance from taxable income encourages employers to offer and employees to demand higher-cost plans.
And benefits are distributed unevenly because the tax code is progressive – it taxes higher income people at higher rates. Why should every dollar of charitable deductions by someone in the 35 percent tax bracket reduce his or her taxes more than twice as much as every dollar of charitable deductions by someone in the 15 percent tax bracket, even if the lower-income person is giving a higher proportion of their income to charity?
TOO MUCH RISK FOR TOO LITTLE REWARD?
Former Treasury Secretary Robert Rubin cautioned both parties Wednesday that a frontal assault on these long-standing tax breaks could have major adverse effects that most Americans don’t yet fully understand. “They are not a silver bullet, and realistic savings may be far less than many plans anticipate,” Rubin said during a seminar in Washington on the economic implications of U.S. debt.
Citing a study by the non partisan Congressional Research Service, Rubin said that barriers to eliminating or reducing most tax expenditures would make it difficult to raise more than $100 billion to $150 billion a year of additional tax revenues. “Tax expenditure proposals may seem like a politically attractive alternative to long standing debates about spending cuts, income tax rate increases, and the like. However, in my view, the tough choices in many ways have just been postponed.”
Republican candidate Mitt Romney signed onto the principle of closing loopholes during his appearance on Meet the Press last Sunday, which was widely panned for lacking details. President Obama has endorsed the goal of lowering corporate tax rates and included a specific approach for reducing tax expenditures in his last proposed budget, which went nowhere in Congress.
The two candidates’ reasons for pursuing tax reform remain very much at cross purposes. Romney and his economic surrogates want reform to be revenue neutral, that is, it should raise the same amount of money for the government that the income tax raises now. He would offset lower rates with a comparable amount of tax expenditure reductions.
Romney said his plan to cut tax rates by 20 percent across-the-board would “keep revenue up.” But he never directly answered the follow-up question about which loopholes he’d close. “People at the high end – high income taxpayers – are going to have fewer deductions and exceptions,” he said. “I’m not reducing taxes on high income taxpayers.”