Tax Analysts Blog

Tax Expenditures Should Be Attacked Head On, Not Through the Backdoor

Posted on Jul 16, 2013

Everybody hates tax expenditures – except voters and the politicians who coddle them. This reality makes it hard to curb the cost of these expenditures, especially when they promote good and popular things like home ownership, health insurance, and pensions.

But tax expenditures are expensive, and reducing them is going to be crucial to any sort of meaningful tax reform. So tax and budget experts have developed some ingenious techniques to cut them without triggering a disastrous political backlash.

These techniques differ from one another in ways both large and small, as the Tax Policy Center pointed out in a recent working paper. Some, for instance, would be relatively simple to administer while others are "mind-numbingly complex." Likewise, some would target wealthy taxpayers quite precisely, while others would involve broader tax increases. "The lesson, you might say, is that a cap is not a limit is not a haircut," concluded Howard Gleckman on TaxVox.

But all these proposals share a single, crucial characteristic: they would cut tax expenditures across the board, rather than one by one.

There's a certain political genius to reforming tax expenditures at the wholesale level. "The practical political problem is that every large tax expenditure – the home mortgage interest deduction, the exclusion of employer payments for health insurance, etc. – has its fervent defenders," explains Harvard economist Martin Feldstein. "So here is an idea that might work politically: Let taxpayers keep all of the current tax expenditures, but limit the total amount by which each taxpayer can reduce his or her tax liability in this way."

But if the wholesale approach makes tax reform easier in the short term, it's likely to make it harder in the future. By confusing and obscuring the operation of various preferences, it makes the tax system as a whole less transparent. That, in turn, makes it hard to talk about tax policy in sensible ways. For a country that already struggles to sustain a useful public discourse around taxation, more opacity is not a good idea.

Tax preferences create a lot of the tax complexity that voters say they hate. But curbing the value of these preferences won't do anything to reduce this complexity. and it would probably make it worse. Backdoor solutions tend to have that sort of effect.

Consider, for instance, another backdoor solution to a different sort of tax problem. The alternative minimum tax had its genesis in another puzzle: how to ensure that rich people were paying enough in taxes. Rather than simply reforming the tax system (including tax preferences) to reach that goal, policymakers chose instead to create a second, parallel system that would backstop the regular income tax. Unfortunately, that backstop turned out to have its own problems, especially for the upper middle class. And ultimately, it didn’t even do a very good job in keeping tax burdens high for the nation’s presumptive plutocrats.(Which has led, ironically, to proposals for an alternative to the alternative minimum tax, otherwise known as the Buffet Rule.)

Notably, the AMT figures prominently in the TPC analysis of across the board tax expenditure reform, since a bigger, badder AMT might serve as a reasonable wholesale curb.

We would all be better off if lawmakers would simply tackle the hard task of real tax reform. That would involve, among other things, making tough decisions about popular tax preferences. The TPC makes much the same point at the end of their analysis: "We agree that across the board limitations of tax expenditures are inferior to policies that address each tax expenditure provision on its merits," the paper concludes.

Political expedients are always tempting, especially in policy realms plagued by partisan paralysis. And to be sure, fighting the battle over tax preferences at the retail level will not be easy. But ultimately, that’s where the battle needs to be won.

As the British Admiral Horatio Nelson famously advised his subordinates on the eve of battle: ''Never mind maneuvers, always go at them.''

Read Comments (1)

edmund dantesJul 17, 2013

Although tax preferences are a problem, the larger complexities begin when you
add preference "phase-outs" such as the phased elimination of the IRA

The best two-prong solution is first, a flatter tax with fewer preferences and
no phase outs, and second, spend less money, so lower taxes become possible.

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