Tax Expenditures are not Loopholes
By Eric Toder :: April 22nd, 2011
George Orwell once wrote: “If thought corrupts language, language can also corrupt thought.” I am reminded of Orwell and his deep concern with the misuse of language for political ends when I see pols of both parties label tax expenditures as “loopholes” or “earmarks.”
The House Budget resolution promises an individual tax reform that “simplifies the broken tax code, lowering rates and clearing out the burdensome tangle of loopholes that distort economic activity.” The Fact sheet describing President Obama’s new budget framework calls for “individual tax reform that closes loopholes and produces a system which is simpler, fairer, and not rigged in favor of those who can afford lawyers and accountants to game it.” The bipartisan National Commission on Fiscal Responsibility and Reform notes that the tax system is riddled with tax expenditures and adds, “These earmarks not only increase the deficit, but cause tax rates to be too high.”
The Congressional Budget Act of 1974 defines “tax expenditures” as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability.” The late Stanley Surrey, a Harvard law school professor turned top Treasury tax official, promoted the use of the term “tax expenditures” to highlight the increased use of the federal income tax as a vehicle for Congress to enact backdoor spending. And they are very big: the annual revenue loss from these provisions now totals more than $1 trillion.
But the largest tax expenditures are not loopholes or earmarks snuck into the law in the dead of night to benefit a shadowy handful of super-wealthy individuals or well-connected corporations. Rather, they benefit tens of millions of taxpayers. Among the biggest: itemized deductions for home mortgage interest, charitable contributions, and state and local taxes, exemption of income accrued within tax-preferred retirement saving accounts, and the exemption from tax of employer contributions to health insurance plans. IRS data show that 39 million taxpayers claimed deductions for home mortgage interest and charitable contributions in 2008, and 35 million deducted state and local income taxes.
Loopholes and earmarks are something entirely different. That great source of all knowledge, Wikipedia, defines a loophole as “a weakness or exception that allows a system, such as a law or security, to be circumvented or otherwise avoided.” From the same source, an earmark is “a legislative provision that directs approved funds to be spent on specific projects, or that directs specific exemptions from taxes or mandated fees.” When people think of “tax loopholes”, they rightly think of sophisticated transactions that enable the well-advised to avoid taxes that Congress wanted them to pay. When they think of “tax earmarks”, they rightly think of narrow and highly technical provisions slipped into legislation at the behest of a compliant Member of Congress. These provisions—once dubbed “rifle shots” — benefit only a few very specific taxpayers (sometimes only one), and are the tax equivalent of appropriated funds given to a single project or congressional district.
Labeling broad provisions that are easy to use and benefit millions of taxpayers as “loopholes” or “earmarks” exaggerates the benefits of tax reform. But worse than deceiving others is the self-deception this misuse of language produces. There are strong arguments for paring back or eliminating some of the large and popular tax expenditures and tax expenditures should certainly not get a free pass when Congress is cutting direct spending. And I agree that restructuring and cutting tax expenditures should be a big part of any effort to bring the deficit under control. But let’s not kid ourselves that these cuts will be easy or that cutting back on provisions like the mortgage interest deduction, exemption of employer-provided health insurance, or retirement saving incentives will affect only a few well-advised taxpayers. And let’s also not kid ourselves that we can raise any significant money from tax expenditures without touching these and other large and popular provisions.