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The State of Our Tax Code Is Weak

Wasteful Tax Breaks and Subsidies Persist, Even as Budget Cuts Fall on Important Federal Programs

SOURCE: AP/Lawrence Jackson

Former Federal Reserve Chairman Alan Greenspan's analysis that tax expenditures are spending—with the implication that they should be subject to the same level of scrutiny as other federal spending—is correct.

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As Congress reconvenes next week for the start of the 2012 legislative session kicked off by the State of the Union address, the top priority should be job creation and not deficit reduction. But members of both parties agree that over the long term, the United States must address structural budget deficits.

Congress last year made significant cuts to federal spending in the Budget Control Act: $2.2 trillion total over the next 10 years, with a wide range of important federal programs affected. But Congress entirely ignored one of the largest parts of the federal budget and the source of some of the biggest waste and inefficiency. That part is the so-called “tax expenditure” budget, which encompasses scores of special tax breaks for individuals and businesses. The tax code is littered with special exemptions, deductions, and other provisions that undermine the code’s fairness, efficiency, and ability to raise sufficient revenue to meet national needs.

Over the past two years, the Center for American Progress’s Doing What Works project has emphasized the need to subject tax expenditures to scrutiny, eliminating or restructuring the ones that are inefficient or no longer serve an important purpose. We have created a new webpage, available here, that hosts all of our recent reports and analyses on tax expenditures, including the “Tax Expenditure of the Week” series reviewing some of the largest ones.

So while critical public investments and services will inevitably face cuts, the government this year continues to subsidize special interests, including large oil companies, hedge funds, and private equity firms, through the tax code. Reforming these tax expenditures must be part of getting our fiscal house in order.

Tax expenditures are really spending programs

A report issued by Congress’s Joint Committee on Taxation this week found that tax expenditures total more than $1.1 trillion per year.* That is about twice the budget for all “domestic discretionary” spending, the part of the federal budget that funds everything the government does outside of “mandatory” programs such as Social Security and Medicare—transportation and infrastructure, public health and medical research, education, housing, environmental protection, food and drug safety, law enforcement, and veterans services. In fact, if combined, the tax expenditures constitute the single largest budget category.

Major categories of federal spending, FY 2010

Economists, tax experts, and budget wonks have long recognized that tax expenditures are really just government spending that happens to be delivered through the tax code. That’s because tax expenditures serve many of the same functions as direct spending programs, delivering similar incentives and benefits at a cost to the federal government. Most companies would not care if they received a government grant for $1,000 or an equivalent tax break to perform the same activity—the effect on their bottom line is the same. And the same is true for the government’s finances.

Former Federal Reserve Board Chairman Alan Greenspan articulated this point in recent Senate testimony:

Cuts in tax expenditures can be alternatively structured, and viewed, as cuts in outlays rather than a reduction in revenues. The deduction for interest on home mortgages, for example, could just as easily have been reconstituted as a subsidy payment to homeowners. Similarly, oil and gas depletion allowances could be restructured as subsidies to producers.

Greenspan has been wrong about a lot of things, but he’s right about that. And his analysis that tax expenditures are spending—with the implication that they should be subject to the same level of scrutiny as other federal spending—is shared across the ideological spectrum. The bipartisan co-chairs of the National Commission on Fiscal Responsibility and Reform emphasized the need to rein in what it called “tax earmarks.” President Obama said last year, “If you’re really serious about the deficit … then part of what you have to look at is unjustifiable spending through the tax code.” House Speaker John Boehner (R-OH) has also recognized the “need to take a long and hard look at the undergrowth of deductions, credits, and special carve-outs that our tax code has become.” These special provisions, said Boehner, are “really just poorly disguised spending programs.”

Making our tax code fairer and our economy stronger

To be sure, many tax expenditures serve important purposes, and many benefit middle-class and low-income families. But others miss their mark: Some have long outlived their purpose, others benefit narrow special interests, and still others intended to benefit the middle class end up disproportionately benefitting the wealthy instead.

In past years’ budgets, President Obama proposed specific tax expenditure reforms aimed at eliminating the most wasteful corporate tax breaks and reducing the disproportionate benefit that wealthy households receive from tax expenditures.

They include:

  • Eliminating oil and gas tax subsidies
  • Eliminating the “carried interest” loophole that allows managers of hedge funds and private equity funds to report most of their compensation to the IRS as capital gains, which are subject to preferential tax rates
  • Limit the disproportionate benefit that wealthy taxpayers receive from tax deductions

These reforms would make the tax code fairer, with fewer wasteful giveaways. They would protect the middle class by ensuring that the wealthy and well-connected pay their fair share of the burden. And ultimately they will enable the economy to grow faster over the long run, both by reducing tax-induced distortions and by reducing the long-term deficit.

The State of the Union address is an opportunity for President Obama to challenge Congress to eliminate wasteful spending everywhere it is found, including the Internal Revenue Code.

Seth Hanlon is Director of Fiscal Reform at the Center for American Progress. For more of CAP’s work on this issue, see our tax expenditures page.

*The Joint Tax Committee estimates the revenue loss from tax expenditures individually without summing up their combined total, and this combined total ignores interaction effects between them. One analysis of certain tax expenditures finds that their overall cost would appear larger if interaction effects are taken into account. Leonard Burman, Christopher Geissler, and Eric Toder, “How Big Are Total Individual Income Tax Expenditures and Who Benefits from Them?” (Washington: Urban-Brookings Tax Policy Center, 2008).

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