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Slay the Sacred Tax Cow

It’s Time to Say No to Wasteful Tax Credits

SOURCE: iStockphoto

Because eliminating tax subsidies can be characterized by their defenders as tax increases instead of spending cuts, they are often perceived as sacred cows that can’t be eliminated.

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Slaying a sacred cow is messy and challenging. But the rewards can be tasty. As Mark Twain said, "Sacred cows make the best hamburger." Many tax breaks are sacred cows worth slaying.

The path to fiscal balance requires both prioritized spending and increased revenues, as CAP has previously noted. A smart way to cut spending is to eliminate wasteful programs and redirect funding streams away from programs that don’t work to programs that do work. One form of spending that often is left out of the discussion, however, is spending that happens to be administered through the tax code.

These "tax expenditures"—the special credits, deductions, exclusions, exemptions, and preferential tax rates that deliver tax breaks—are functionally equivalent to government spending aimed at achieving a public policy objective. For example, say the government wants businesses to make their facilities more accessible to the disabled. It could offer businesses grants for taking action—government checks would subsidize building ramps, making restrooms wheelchair accessible, etc—or it could offer a "architectural barrier removal tax deduction" and a "disability access tax credit." These tax credits, just like a direct check, would subsidize businesses that make their facilities more accessible. The difference? Businesses get the money by paying lower taxes instead of through a government payment.

Spending administered through the tax code costs the federal government more than $1 trillion each year—which is more than 25 percent of its total spending.

Some tax expenditures are good. The Earned Income Tax Credit is one of the largest antipoverty programs and enjoys broad bipartisan support for alleviating poverty and creating an incentive for low-income earners to join or stay in the workforce.

But other tax expenditures are more problematic. A host of corporate tax breaks litter the tax code. The "alternative fuels provision" tax credit pays paper producers about $4 billion a year to burn diesel fuel. This credit is intended to promote the use of alternative fuels in cars, but paper companies found a loophole in the provision that allows them to take advantage of this spending program. If the loophole is not closed, taxpayers will continue paying paper companies billions to burn fuel they want to burn. This is but one of many tax breaks that reward special interest lobbyists. Another is the preferential tax rate for timber sales, which together with other special timber tax breaks results in a negative tax rate on the timber industry, meaning the government actually pays timber companies to make money.

Tax expenditures for individuals can be similarly wasteful. The home mortgage interest deduction, at a cost of over $100 billion, is intended to help people afford the expenses of homeownership. Promoting homeownership is good public policy, but this spending program wastefully provides subsidies for the purchase of second homes. This makes it an enormous subsidy for vacation homes. And what’s more, it applies to mortgages of up to $1 million. Not surprisingly, more than 75 percent of the $100 billion will be enjoyed by taxpayers earning over $100,000.

Getting rid of or fixing such ill-conceived and costly tax expenditures can save the government considerable money. Tax expenditures provide funding support for more than half of the government’s energy policies and almost 100 percent of the government’s commerce and housing policies, but they are not thought of as spending even though they have the same effect. They aren’t included in the congressional budget process and receive less scrutiny than direct outlays, which makes them legislatively attractive. This means the government can support programs through tax expenditures without having to track such spending in the budget. And because eliminating these tax subsidies can be characterized by their defenders as tax increases instead of spending cuts, they are often perceived as sacred cows that can’t be eliminated.

But Oregon voters recently showed that sacred tax cows can be slain. Fifty-four percent of Oregonians voted in a public referendum to reduce a tax deduction on the state income tax for federal income taxes paid. The new law will eliminate this tax subsidy for individuals earning more than $125,000. The nearly $500 million raised will go toward keeping public schools open and providing health services. Without this revenue, Oregon would have been forced to shut down schools early. That’s what happened in 2003 when a different proposal was voted down and teachers volunteered to work a week for free in order to keep schools open.

Corporate lobbyists and the 3 percent of high-income taxpayers that would be affected lobbied hard against cutting this tax expenditure and other tax measures. After Oregon’s legislature passed the measures and the governor signed them into law last year, these lobbyists collected enough signatures to force a referendum on these bills, believing that the public would not slay a sacred cow. But in the end, they did not prevail. The public voted yes on the ballot.

Other states are also recognizing that cutting wasteful tax expenditures is a necessary part of doing what works. Missouri State Senator Jason Crowell introduced a bill earlier this year that would subject the state’s $544 million tax expenditure budget to review. A panel formed by Iowa’s governor voted to eliminate eight ineffective tax expenditures, a move that would generate more than $150 million over the next two years. And a report released in Virginia, which exposed the obscure and wasteful subsidies in Virginia’s $2.5 billion tax expenditure budget, prompted legislation that would require Virginia to annually scrutinize its tax expenditure spending annually. Washington state already does something similar. It has a process in place for scrutinizing tax expenditures and has integrated them into its annual budget process.

The lesson to be learned is that scrutinizing and cutting wasteful tax expenditures is a necessary part of fiscal planning. And leading states are showing that it’s doable. Congressional leaders should take note. It’s time to put the tax expenditure cow on the table.

Sima J. Gandhi is a Senior Policy Analyst with the economic policy team.

This column is part of the Doing What Works project, which focuses on government reform and efficiency. Click here to learn more about Doing What Works.

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