No New Taxes: A Pledge That Isn’t As Simple As It Seems

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

Bush Tax Cuts Turn 10, Having Added $2.6 Trillion to Our Debt

In honor of the tenth anniversary of the passage of the first Bush-era tax cuts next week, the Economic Policy Institute has released a report summarizing their impact. Perhaps I should say, “in dishonor of the anniversary”, as it is pretty clear where the authors stand on the cuts: “[T]he Bush tax cuts have exacerbated the trend of widening income inequality, accompanied the worst economic expansion since World War II, and turned budget surpluses into deficits.”

While much of their report summarizes existing research, it’s interesting to consider in light of current debates about the deficit and our long-term budget crisis. According to EPI, the Bush-era tax cuts added $2.6 trillion to the national debt, almost half of the new debt we accumulated over the past decade, and have already cost $400 billion in increased interest payments. This recent graph from the Center on Budget and Policy Priorities shows that the cuts added more to our debt than the Iraq and Afghanistan wars, the recession, or the economic stimulus measures implemented under Obama.

The authors of the EPI report also remind us that the tax cuts were originally designed as a response to the 2001 recession, but they suggest the cuts were/are a less effective form of economic stimulus than the tax credits that were included in the 2009 recovery package:

“Moody’s Analytics Chief Economist Mark Zandi estimates that making the Bush income tax cuts permanent would currently generate only 35 cents in economic activity for every dollar in forgone revenue. Targeted refundable tax credits included in the American Recovery and Reinvestment Act, on the other hand, are estimated to generate much more bang-per-buck, ranging from $1.17 for the Making Work Pay Credit to $1.38 for the Child Tax Credit.”

When you think about it in terms of the national debt, which affects everyone, the inequality in the benefit of the tax cuts is quite startling. During the 2010 tax year, 38% of the Bush-era cuts went to those with incomes in the top 1% (over $645,000) and 55% went to those with incomes in the top 10% (over $170,000). Only 1% of the cuts went to families with incomes in the bottom 20%.

I’ll have another post soon on how much letting the cuts expire at the end of 2012 might help our debt crisis.

Tenth Anniversary of The Bush-era Tax Cuts: A decade later, the Bush tax cuts remain expensive, ineffective, and unfair.
Economic Policy Institute // Andrew Fieldhouse and Ethan Pollack // June 1, 2011