Let’s Bribe Taxpayers To Give Up Tax Breaks
Sensible budget wonks of all political stripes understand that a solution to our looming budget crisis will require more tax revenues. The aging of the baby boomers and rising health care costs will push up government spending. Yes, I know that we have to slow the growth of health spending and we definitely should look for wasteful or ineffective programs to cut, but spending will go up.
Of course, not a single House Republican is willing to publicly acknowledge this obvious fact. They’re all in the thrall of Grover Norquist’s no-tax pledge, which Lori Montgomery reported he dreamed up as a 14-year-old boy. Fact is, most of the ideas that pop into the adolescent male mind would be a poor guide for public policy and none more so than “the pledge.” Then again, male politicians of both parties seem particularly prone to adolescent behavior. (But there are 24 Republican women in the House. Surely, they’re immune to male adolescent fantasies…)
But I digress.
As Lori discusses, at least in the Senate, some Republicans are open to the idea of cutting “tax expenditures”–the tax credits and deductions designed to subsidize particular activities. In fact, just yesterday, the senate, including most Republicans, repudiated Grover by voting to end ethanol tax breaks. It’s a small step, but suggests that perhaps the dark lord’s death grip on sensible budget policy is weakening.
Cutting tax expenditures is appealing because revenue would rise without requiring higher tax rates. Conservative economist Marty Feldstein has proposed limiting the value of tax expenditures to 2 percent of income. Since the value of tax breaks tends to rise with income, the proposal would be progressive. And it would raise a lot of revenue. Feldstein estimated that a fairly comprehensive cap could cut the deficit by almost half over time.
The obvious problem with cutting tax expenditures is that people like their tax breaks. They include popular items like the mortgage interest deduction, tax-free health insurance, and the charity deduction.
Another problem is that even if voters could somehow be convinced to support big cuts, raising taxes (or cutting spending) significantly right now could thrust the fragile economy back into recession.
There may be a solution to both challenges. We know that Americans are impatient. Why not bribe them to give up their tax breaks? For example, suppose that individual income tax breaks are worth about 10% of adjusted gross income. (This is probably not a bad approximation, but I haven’t crunched the numbers.) It’s unrealistic to assume that all could be eliminated, but we might be able to cut the cost of tax expenditures by half. (See the Bipartisan Policy Center plan, which I helped craft, as an example of how to do this.)
We could phase in a version of Feldstein’s plan by offering a “tax break credit” of 10% of AGI for tax year 2011 in exchange for eliminating tax breaks worth 5% of income. The credit rate could be phased down to 2% of AGI over 5 years. For the first three years, this would be a tax cut compared with current law and provide a needed economic stimulus . To make the stimulus even more effective and help those most in need of aid, the first $5,000 for joint filers could be made refundable ($2,500 for single returns). That amount could also be phased down over time. This would raise taxpayers’ incomes by roughly half a trillion dollars in 2011, and smaller amounts in 2012 and 2013, providing a helpful prod to the economic recovery.
The bottom line is that this plan would boost the economy in the short term, substantially reduce the deficit over the long term with tax rates, and significantly simplify the tax system.
Since I’m a tax geek, I want to get into some technical stuff below. Non-geeks can stop reading now.
Unlike Feldstein’s plan, which caps tax breaks at 2% of AGI, a simpler approach would be to simply deem tax breaks equal to that amount. Set a floor on the credit equal to 15% of the standard deduction and then the standard deduction can be eliminated also. (In Feldstein’s plan, taxpayers have to decide whether to take the standard deduction or itemize subject to the AGI cap.) In addition, the AMT should be eliminated. It wouldn’t cost much if major “preference items” like the state and local deduction were also eliminated.
Some provisions would have to be phased in. For example, part of the plan should be to cap or eliminate the tax exclusion for employer-sponsored health insurance. There’s a near consensus that this exclusion is poorly targeted and contributes to rising healthcare costs. However, it wouldn’t be possible to limit the exclusion in 2011 because employers are not required to measure and report the value of health insurance benefits until 2012.
Also, it would be unfair to prevent taxpayers from taking tax breaks they had counted on this year. Thus, they should be allowed to elect to claim all of their tax breaks in 2011 in lieu of the credit. Most taxpayers would not make this election, but this transition rule is probable necessary.
An earlier version of this post was originally published on my Forbes blog.
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It would only perpetuate the unfairness of the current income tax structure if income tax deductions for middle class taxpayers were decreased before marginal income tax brackets for taxable income over $1M were increased. Please, don’t demand more sacrifice from the middle class before the rich bear their share of the burden.
I agree that tax expenditures should be made transparent and fair. I think the accounting should be turned around into a refundable credit rather than an income deduction.
Here is how I would set it up: The “individual income tax return” would list all income from all sources, NO exceptions. The tax due would be looked up in a table.
A second form, “Claim for individual federal subsidy”, would list all the subsidized activities. These might include half of any long-term capital gains, tax exempt dividends, mortgage interest and so forth. The subsidy claimed would be found by using exactly the same table used to calculate the taxes due.
This scheme is simple and fair.
This is not a bad suggestion. To take your comment one point further, the taxes raised with respect to the actual tax return would be placed on the credit side of the government income statement (as “taxes”). And, the funds expended on the “claim for individual tax subsidy” would be placed on the debit side as “spending”.
Thus, the more important substantive point is about the accounting for the two and not on which form each is calculated. Having said that, the idea of two forms has some very good psychological advantages. The lesson with respect to tax expenditures is that form matters as much as substance.
Hi Viv [or is it Vlad?]
Your points are exactly mine. The psychological aspects and the placing these expenditures on the debit side are important.
Your remarks also make me think that the subsidy calculation should be flat … mmaybe 20% or so.
As an aside [actually my main objective] how can I get someone at the tax policy center to “run the numbers” on this idea, or tell me where to access the data to do it myself.
This is all a mess. The tax policy needs to be modified or replaced with a system that encourages economic recovery. Until we get that we will be stuck in neutral.
The more revenue the government collects the more it spends. Period. Then, that revenue won’t be enough and you’ll have to raise taxes again. And then again. Soon, you are Greece.
So, go ahead, cap all tax expenditures at 2% of AGI. Fine. But if you don’t get some guarantees on spending, like a Balanced Budget amendment, in return, then you really haven’t fixed anything. You’ll have only postponed your difficult decisions, again.
Any limit on tax expenditures will come with a commitment to control cash outlays.
That said, tax expenditures are tantamount to spending, so if you favor limiting government, you should favor reducing tax expenditures (even if other spending were unconstrained). A lot of tax expenditures are astonishingly inefficient and poorly targeted and would not pass muster if they were run through HHS or HUD (for example). They shouldn’t get a pass just because they masquerade as tax cuts.
I’m not at all convinced by the “starve the beast” theory. I think if people have to write bigger checks to the IRS, they’re more likely to favor spending limits than if they think new government programs are free (because it’s unclear who’s on the hook for deficit spending). Bill Niskanen, president of the libertarian Cato Institute has made this argument and presented some empirical evidence in support of it. Bruce Bartlett, an old Reagan supply sider (whose views have evolved in interesting ways) has made the same point.
I agree with this comment, particularly the following, sentence, but with one significant revision:
“I think if people have to write bigger checks to the IRS, they’re more likely to favor spending limits than if they think new government programs are free (because it’s unclear who’s on the hook for deficit spending).”
I completely agree that having to write a “bigger check” would have the result you mention, particularly if that tax expenditure spending is replaced by more visible direct spending. If you believe this, as I do, then you must also believe that writing any check at all would have the same salutory effect. In fact, I think it would have a more significant effect. People who now actually write checks, regardless of size, feel the pain when those checks are written, and tend therefore, to be more critical about our spending choices. A majority of people in the US don’t write any such income tax checks and if this doesn’t not change I don’t see how increasing the pain on an already signficant minority is going to positvely affect attitudes much about spending limits.
I agree that those who have to write a check are most against government spending. To me this is why many of those who look favorably on the tea party are self employed or small business owners. When you write a quarterly check for 15% (ssi) + your tax rate to the IRS you gat a real appreciation for how much we are taxed. Those who have their taxes withheld do not get to consider extra 7.5% employer tax, which really is deducted from the wage you WOULD make. I greatly favor having all people pay federal tax, even if it is at a 10% rate so that decisions to expand entitlements are seen to have some “cost”.
Actually, it is more likely that if you raise taxes, spending will also be cut. Indeed, when taxes go up there is more of a demand for spending cuts – and the higher the effective tax rate, the more substantial the cuts. Cut taxes, however, and someone else is paying for more services – so the demand for services goes up as well. That is why spending ballooned under Bush II and went down under Clinton.
When I was 14, my idea was to reorganize the executive branch by consolidating departments and independent agencies along functional lines. Word has it OMB is working on something like that, at least that’s what Obama said in his State of the Union this year.
When I was 16, I came up with the concept of reducing abortions by increasing tax benefits to families.
That one is still a good idea. If you ended the mortgage interest and property tax deductions you could up the child tax credit to $500 per month per child (also eliminating the dependent deduction). Unlike using this money to bribe wealthy taxpayers to give up deductions, the money transfered would likely still go to housing – especially if the added tax benefits cause people to upgrade if their housing is inadequate or to have that extra child or two and get a bigger place. This is also good for Social Security and Medicare in the long run – since the only way out of a demographic crisis is a demographic solution.
The GOP makes a lot of noise about not wanting to raise taxes.
Let them. If there is no compromise, the baseline resets to Clinton era tax rates automatically. I agree with Alan Greenspan that this would not be so bad. I suspect most of the voters think that too.
The second the President says he won’t raise taxes on anyone who is not wealthy, he has no room to bargain. I don’t think he will make that mistake again. If his position is letting all the cuts expire, the GOP might settle for something in the middle and the White House may agree to spending cuts.
This should have been the strategy last year. Maintaing the tax cuts didn’t quite give us the recovery promised by the powers that be. Indeed, why should anyone with a tax cut work harder? People mostly work to meet their needs, not get rich. If you are flush with cash, there is no need to expand a business. People who are hungry expand and take risks, including capitalists and small businesses. Increasing tax rates on the top 3 or 4 rates might lead to people hiring folks, since wages paid to others are deductible.
Fiscal policy is not the way out of the current bad economic cycle – since the trouble is caused by too many people with more loan than house – or just declining housing values – which makes them not want to spend. If you reduce the loans, either through bankruptcy or principal modification (marking the securities to market as well) – especially when Freddie and Fannie own the paper – then the uncertainty stopping real recovery will be settled.
Obama could likely do this without the House Republicans. TARP authority could very well be enough. If that is the case, he should do it. The Federal Reserve could certainly buy out Freddie and Fannie’s bad loans and do the modifications themselves – that would not require any legislation at all. It also would not cost taxpayers anything in the short term – since the assets won’t be worth their loan value anytime in the forseeable future. The loss has already occurred and it should now be booked.
“Cutting tax expenditures is appealing because revenue would rise without requiring higher tax rates. ”
Hey, I thought tax expenditures were more or less equivalent to spending? So, shouldn’t this read “Cutting tax expenditures is appealing because spending would decrease allowing tax rates to stay the same”?
As far as the specific proposal is concerned, it will all fall apart, of course, over fights over which “tax expenditures” are “feasible” to eliminate and which are not. Let’s not kid ourselves, for most people this discussion is all about the re-distributional effects of any proposal and nothing more. For example, eliminating the taxable income exlcusion for employer-provided health insurance is a good idea and much more efficient than the Cadillac tax for reducing medical care costs. But, within the existing framework of the Affordable Care Act, it just won’t fly. Unless the ACA is repealed or substantially reformed, eliminating the tax benefits for employer-provided insurance will just accelerate the death of private health insurance, which is the aim of the ACA proponents anyway , and pave the way for single payer. This is just not in the cards and sounds like someone’s adolescent dream to me.
If the objective is to reduce the complexity of the Code, I don’t understand the logic behind putting a floor on the standard deduction and then a ceiling on tax breaks at 2 percent of AG (that is, “deem the tax breaks to be that amount). This is unnecessarily complicated. One would better simply lower tax rates across the board to account for this and be done with it. The Code could have a reasonably progressive tax rate structure with no tax expenditures at all. Now, that’s an adolescent dream.
One which rewards sticky fingers of the wealthy – double meaning intentional.
Tax simplification should be a bit more complicated, not with more people filing at lower rates, but with consumption taxes (a VAT and a Net Business Receipts Tax), much higher credits for children and a progressive income tax for income under a fairly high floor.
Only an adolescent could have made that disgusting comment.
It is a natural comment when talking about adolescent dreams – and there is nothing more adolescent than reading Atlas Shrugged and thinking taxes are too high.
Mr. Bindner,
While this comment is not puerile, it certainly lacks substance and therefore, under the standard definition, could certainly be considered “ad hominem” or, better “ad feminem”. You’ve made two assertions here that have absolutely no foundation and seem to be a product of your over-active imagination.
First, you somehow are asserting that you’ve taken a peek into my mind, my private library, or both, but I can assure you that I have never read “Atlas Shrugged” or any other work by Ayn Rand.
Second, you have suggested, quite improperly, that I think taxes are too high. I would kindly ask you to point out to me from where this supposition is taken. In fact, I think taxes are too low, and that a rise in tax is necessary, together with spending cuts, to reduce our federal deficit.
Again, if you want to reply to me, please keep your comments on topic and factual.
I just googled you and now find it rather bizarre that you are objecting to a double entendre, given the source of your online monicker.
Another thing. If you want to reply to something I have written in a meaningful substantive way, feel free to do so. But, if you want to engage in creepiness, I’m sure that there are other sites in which you can correspond with people who want to do that. I don’t.
I apologize for the sticky fingers comments. However, paragraph two had merit – indeed much more merit than repealing the ACA. Private insurance will end under the ACA and it will be amended, not repealed – likely through offering a public option to all denied insurance, with subsidies that will require a broadening of payroll taxes into a full fledged net business receipts tax.
Vivian,
Thanks for your comments. I think you read too much into my proposed alternative to Feldstein’s plan. The basic idea is a tax credit equal to the minimum of, say, $1,800 for couples ($900 for singles) and 2% of AGI, with the minimum indexed for inflation. That’s roughly 15% of the standard deduction. It’s way simpler and more progressive than current law.
Feldstein’s plan (I should also credit his coauthors Maya Maguineas and Dan Feenberg) would require taxpayers to calculate their tax liability with and without the specified tax expenditures and limit the value of the tax expenditures to 2% of AGI. It’s effectively another AMT–feasible for taxpayers who use software but incredibly complex for people who want to prepare their taxes by hand. As a practical matter, my proposal would produce similar or identical tax liability and be relatively straightforward.
I don’t think Michael was trying to be creepy, although can understand why you took his comment that way. I hope he’ll clarify his intention and apologize. One thing I love about Taxvox is that the discussions are almost always civil even when there are intense policy disagreements. I appreciate your contributions in that vein as well as Michael’s.
You wrote in the main article:
“Unlike Feldstein’s plan, which caps tax breaks at 2% of AGI, a simpler approach would be to simply deem tax breaks equal to that amount.”
You also wrote, in conjunction with the first sentence, that:
“Set a floor on the credit equal to 15% of the standard deduction and then the standard deduction can be eliminated also.
Now, you write:
“The basic idea is a tax credit equal to the minimum of, say, $1,800 for couples ($900 for singles) and 2% of AGI, with the minimum indexed for inflation. That’s roughly 15% of the standard deduction. It’s way simpler and more progressive than current law”.
Respectfully, I don’t think I was reading too much; it appears you were writing too little. In the original article, it appeared that the “credit” would be the greater of:
a) 15 percent of the standard deduction; or
b) 2 percent of AGI.
Nothing in what you wrote suggested there would be anything in between.
What you now write in your comment to me is something different. It indeed suggests an alternative and simpler form of AMT, although I would think it sounds more like a cap on itemized deductions such as the Pease Phaseout rules.
My position is that this is still too complicated and unnecessarily so. I don’t know why we want to continue to mess with the concept of targeted deductions at all. Do away with all of them and set up a progressive tax rate schedule that normal citizens and taxpayers can understand and that takes spending completely out of the Code.
As far as Mr. Bindner is concerned, I don’t need any apology from him. Hopefully, Google will already have cached his comment so that he can have his Andrew Weiner moment forever. One of the reasons I come to sites like this is that reasonable, intelligent and well-intentioned people can have civiized substantive debates about public policy issues we face and I find that kind of crap distracts from that purpose.
Another couple of points about the Feldstein proposal which I think demonstrates that it is not worth all the trouble and complexity:
1. I think the proposal is meant to be combined with reducing tax rates. Let’s assume that the marginal tax rate is 30 percent. If “tax expenditures” (however, they will be defined, which is a very significant practical point) are limited to 2 percent of AGI, then the maximum possible effect would be a reduction of something like 0.6 percent in one’s effective tax rate. That’s a pretty insignificant in comparison to the complexity his proposal would ential. Is it really worth all that trouble?
2. Feldstein’s proposal leaves in place a system, similar to the one we’ve now got, in which the Code would be littered with all sorts of special interest deductions, albeit the effect of those deductions would be very limited. I view this sort of like a Christmas tree. The proposal suggests that we leave the tree standing, but that we take away a lot of the ornaments (or dim the lights significantly). Experience shows, I think, that if this type of infrastructure is left in place, there will be a very, very strong tendency for politicians to later start putting ornaments back on that tree. Taking the tree completely down would significantly hamper such a development.
The problem I’ve got with a lot of tax policy experts, and I think Feldstein fits this category, is that, as economists exclusively, they come to the table with a lot of grand ideas about how a future tax code should look, but they don’t really seem to have a good understanding of how the existing one works.
OK, regarding my point 1, it is quite possible that the original meaning of the Feldstein proposal was, by “limiting the value” of the tax expenditure to 2 percent of AGI. This implies, perhaps, a credit rather than a deduction (this is made more clear in the “description of the Burman alternative” and I perhaps did not link the description of the latter sufficiently to the former). If so, the maximum effect on effective tax rates would be 2 percent.
Either way, the amount of complexity this entails is just not worth it and one should just do away with it all and lower tax rates fractionally to compensate.
I can’t speak for Marty, but I’ve read his stuff on tax expenditures for a long time and am pretty certain that he’d like to eliminate most of them altogether. So would I (although our lists would differ in important ways). But voters like tax expenditures, which is why there are so many of them. The question is whether there’s a way to wean ourselves of them gradually. Think of it as replacing cigarettes with the patch–not the first best solution, but certainly way less destructive than smoking. And, possibly, given human weakness, it has a better chance of working than quitting cold turkey.
Correction: I meant the maximum of $1,800 for couples and 2% of AGI (not the minimum).
Thank you for this correction, which I think in part explains my confusion over what you are proposing. But, although I happen to be a tax geek, I’m still not certain I understand what you are driving at. I am particularly confused now by your earlier description which spoke of a “floor” on the tax credit. You also wrote that the proposal would “deem” the credit to be 2 percent of AGI. The latter description suggests that one gets the credit regardless of actual deductions. Now, you speak of a “maximum” credit, which suggests that actual deductions are actually relevant but here you no longer mention a “floor”. I hope you can understand my confusion and help me to overcome it.
Perhaps an example is needed since they are usually better than narrative descriptions.
Let’s assume that we’ve got a couple that earns $500,000 of AGI and has $100,000 of otherwise deductible “tax expenditures”. Let’s further assume that the “value” of those expenditures at the couple’s marginal rate is $30,000 (i.e. it would result in a reduction of tax in that amount before your proposed limit). Taken literally (you wrote the maximum is $1,800 *and* 2% of AGI), your explanation would limit the couple to a tax credit of $11,800 ($1,800 plus the product of 2% times $500,000). Perhaps this is combined with the idea that if said couple (or any other) had no tax expenditures, they would nevertheless be entitled to a tax credit of $1,800).
Or, if you’ve written less precisely, I could suspect your proposal to allow a credit to couples of $1,800 *or* 2 percent of AGI *whichever is greater* (in my example $10,000). Somehow, I suspect this is what you may have meant to write, but I’m not completely sure.
I agree that radical changes in the Code, such as I am suggesting, might be superior but more difficult to implement given politically. Nevertheless, it would be my perhaps unrealistic hope that if tax rates were ratably reduced to account for the elimination of the expenditures, taxpayers and politicians might be convinced to go along.
I continue to think that your idea of “weaning” taxpayers from these expenditures might just work in the opposite way you intened. That is, to refer again to my Christmas tree metaphor, that it might just result in a future re-decoration of that tree rather than a further dismantlement. There is also, I think, a certain amount of stealth implied in your proposal. That is, by “weaning” taxpayers from these expenditures, you may be implying that, other than those who are really in the know, we sell the proposal to taxpayers as an ostensible final package and then slowly inform them of the intent by making gradual additional reductions. I know this type of “creep” technique (no, not *that* kind of creep) is a common political tactic, but I would much more prefer that, in a democracy, we try the more straightforward approach first.
On top of that, this proposal would likely result in almost all the tax expenditures we now know remaining on the books so that everyone continues to get a little from the trough, albeit in reduced amounts. I don’t prefer that from the complexity standpoint. It is likely that as your proposal goes through the political process, we’d end up with an even more complex limitation mechanism than the existing AMT (or AMT combined with Pease and PEP).