Debt-Limit Debate Has Come Down to What Spending Will Be Cut
Seth Hanlon explains how the debt limit debate underway in Washington isn’t really about spending versus taxes, as conservatives claim—it’s about whether conservative lawmakers are willing to put wasteful tax code spending on the chopping block.
Republican negotiators walked out of negotiations over the federal debt limit last week after Vice President Joe Biden and congressional Democrats suggested that a deal to raise the nation’s debt limit should include cuts and reforms to the following federal spending programs:
- The Department of Transportation program that provides interest-free loans for purchasing corporate jets
- The Department of Energy program that rewards oil companies for extracting oil in the United States and overseas through several different types of government rebates
- The Department of Agriculture program that pays companies 45 cents for every gallon of corn ethanol they blend into gasoline
- The Department of Commerce program that incentivizes people to become hedge fund managers by sending them an annual U.S. treasury check for 20 percent of the cut they take from managing investors’ portfolios
- The Department of Housing and Urban Development program that matches people’s mortgage interest payments, which is targeted to provide the most help for people earning more than $379,150
Senate Republican Leader Mitch McConnell (R-KY) declared these programs “off the table.” He and his colleagues are insisting that spending cuts be limited to other federal programs, including Medicare and Medicaid.
Why are conservatives so opposed to cutting these wasteful programs? Well, part of the reason is that they aren’t actually administered by the above-referenced agencies, but rather by the Internal Revenue Service. And although they have the same effect as spending programs, they are actually special provisions of the tax code.
These types of special tax breaks, called “tax expenditures,” are functionally and economically equivalent to government spending. Economists often refer to tax expenditures as hidden federal spending programs, or “spending in disguise.” After all, whether the government gives a large oil company a special break that reduces its tax bill, or simply mails it a check, the effect is the same.
Most tax expenditures could easily be redesigned as direct spending programs, and the only thing that would change is how they are accounted for in the budget. (And the absurdity of many of them would become obvious.)
Given the reality that tax expenditures are simply spending by another name, it makes no sense to declare them off the table while direct spending gets the ax.
So what is this impasse over tax expenditures really about? By declaring tax expenditures off limits, Republican negotiators are protecting an assortment of special-interest provisions that represent wasteful spending at its worst.
Consider for example the “percentage depletion” tax break, one of several tax expenditures benefiting the oil industry.
Companies are generally allowed to claim tax deductions for the costs of an investment over the term of that investment’s useful life. But oil companies get to use a special method for calculating their deductions, called percentage depletion. Instead of deducting the costs of an oil or gas well as its value declines, oil companies are allowed to deduct a flat percentage of the income they derive from it.
The federal government might as well treat these companies like most other companies for tax purposes and then authorize the Department of Energy to send them a rebate check rewarding them for extracting oil.
Percentage depletion will cost the U.S. treasury $11 billion over the next 10 years—a decidedly questionable public investment at a time when oil prices have driven industry profits to record highs.
Such examples also make clear that the debt-limit negotiation, as it has developed, isn’t really about spending cuts versus revenue increases. It’s now a standoff over what spending to cut. If direct spending programs like Medicaid that benefit seniors and low-income Americans are on the table, then shouldn’t hidden-spending programs subsidizing oil companies, business inventories, and hedge fund managers also be on the table?
Indeed, ultrawealthy individuals are among the biggest beneficiaries of the tax spending that conservatives want to protect. One of the proposals that prompted them to walk away from the negotiating table was to scale back itemized deductions for households earning more than $500,000 per year.
Well-to-do households benefit disproportionately from these deductions, which largely subsidize mortgages, charitable giving, and other things. Those who earn more than $500,000 comprise less than 2 percent of all tax filers, but claim 15 percent of all itemized deductions—over $200 billion worth. They also benefit more from those deductions than other taxpayers because of the “upside down” effect. (People who earn more than $379,150 get the most benefit because they claim the deductions against the 35 percent top tax rate.) All told, the wealthiest 1 percent of taxpayers receive upwards of $40,000 in tax benefits from itemized deductions on average, compared to about a meager $140 for households in the middle quintile. 
It makes no sense—as social, economic, or fiscal policy—to provide the highest income earners with the biggest benefits from these hidden spending programs. If itemized deductions were structured as direct spending programs, as they easily could be, we’d be outraged that the largest benefits accrue to the highest-income households. And if we needed to reduce the deficit, modestly limiting the outsized benefit for those at the top would be a no-brainer. That’s what Democratic negotiators on the debt limit have reportedly proposed with itemized deductions.
Before the breakdown of debt limit negotiations last week, there had been glimmers of hope that conservative lawmakers would begin to recognize that tax expenditures are spending. Two-thirds of Republicans recently voted to end ethanol tax subsidies. And many conservatives have called explicitly for treating tax expenditures as spending. In the words of House Speaker John Boehner (R-OH), “We need to acknowledge that what Washington sometimes calls tax cuts are really just poorly disguised spending programs.”
He’s right. And if we take the disguise off, we could have a much more productive conversation about reducing deficits and debt.
Seth Hanlon is Director of Fiscal Reform for the Center for American Progress’s Doing What Works project.
 IRS Statistics of Income, Publication 1304, Table 2.1 (2008).
 Author’s calculations based on Leonard Burman, Eric Toder, and Christopher Geissler, “How Big are Total Individual Income Tax Expenditures, and Who Benefits from Them?” (Washington: Tax Policy Center, 2008), Table 2, counting interaction effects, available at www.taxpolicycenter.org/UploadedPDF/1001234_tax_expenditures.pdf. Part of the reason middle-income households receive so little benefit from itemized deductions is that they claim the standard deduction instead. But for middle-income couples in the 15 and 25 percent brackets, the standard deduction provides tax savings of only $1,740 and $2,900, respectively—nowhere near what top earners receive from itemized deductions.
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Former Acting Vice President, Economy