Like a household whose finances are out of whack, our government can deal with its looming budget deficit in two ways: spend less or earn more. Political leaders are currently negotiating to find the right balance of these two strategies, but several Republicans have threatened to block any plan that involves raising taxes. In our current Congress, all but 7 Republican Senators and 6 Republican Representatives have signed Americans for Tax Reform’s well-known pledge to oppose any and all tax increases (only 3 Democratic Congressmen have signed).
But hewing to a mantra of “no new taxes” can be more complicated than it seems, because the division between taxes and spending isn’t always clear-cut. A significant amount of government spending is hidden in the tax code in the form of tax breaks for certain groups: homeowners making mortgage payments, companies conducting scientific R&D, workers receiving employer-sponsored health insurance, and investors earning capital gains. Altogether, the Treasury Department has identified over 170 preferences that cut taxes for specific taxpayers, activities, or types of income. If these “tax expenditures” were structured as spending programs rather than tax breaks, in 2007 they would have accounted for 17% of federal spending.
What makes these tax breaks different from other parts of the tax system, like differential rates based on taxpayers’ incomes? According to a new article by Donald B. Marron, Director of the Urban-Brookings Tax Policy Center, tax expenditures have the same impact on the economy, government budget, and distribution of income as if the government directly handed out checks to the beneficiaries. Elected officials use the tax system because it’s legislatively easier and politically more palatable to insert a benefit into the tax code than to increase discretionary spending by a comparable amount.
“Because tax cuts often sound more appealing to policymakers and voters than spending increases — especially in today’s political climate — the temptation to spend through the tax code is enormous.” – Donald B. Marron, “Spending in Disguise”
Unfortunately, politicians find it much more difficult to eliminate a tax break than to cut a comparable spending program. We saw this a few weeks ago when anti-tax Republicans struggled with how to vote on a measure to end tax credits for ethanol producers. Some, like Senator Tom Coburn, saw the credit for what it is – a spending program in disguise – while others stayed true to their promise not to vote for tax increases of any kind and rejected the measure.
Marron suggests that by eliminating or simplifying many existing tax expenditures we can streamline the tax code, decrease government involvement in the economy, reduce the deficit, and maintain or perhaps even lower tax rates. But eliminating tax expenditures won’t be painless. Despite our stereotype of massive corporations receiving huge breaks – see Obama’s latest rhetorical target, accelerated depreciation for corporate jets – only 10% of the revenue lost to tax expenditures benefits corporations. The other 90% of breaks are for individuals, though many deductions disproportionately benefit the wealthy.
Sometimes spending through the tax code makes sense: it may be more efficient, accomplish important policy objectives, or benefit a broad spectrum of taxpayers. In other cases, these approaches can be overly complex and used to hide unpopular programs that benefit a select few. But the biggest problem is when politicians and voters don’t see tax breaks, good or bad, for what they are – a form of spending – and treat them accordingly.
Spending in Disguise
National Affairs // Donald B. Marron // Urban-Brookings Tax Policy Center // Summer 2011