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Cutting Tax Expenditures

The Other Savings in President Obama’s Budget

President Barack Obama’s new budget for fiscal year 2012 contains substantial cuts in government spending, including a five-year freeze on non-security discretionary spending that amounts to $400 billion in cuts. Many critics fault the president for not going far enough, but these critics ignore the substantial savings his budget makes by cutting some of the least effective spending programs—those that dole out special breaks through the tax code.

In the words of the National Commission on Fiscal Responsibility and Reform, “Washington has riddled the system with countless tax expenditures, which are simply spending by another name. These tax earmarks—amounting to $1.1 trillion a year of spending in the tax code—not only increase the deficit, but cause tax rates to be too high.” As the commission members emphasized, deficit reduction is next-to-impossible without substantial tax expenditure reform.

The budget for fiscal year 2012, which begins in October, underscores the point: The combined cost of tax expenditures ($1.08 trillion) is more than twice as large as the domestic discretionary budget ($462 billion)—the only area that congressional Republicans have targeted for cuts.

The newly released budget takes concrete steps toward reducing tax code spending. Perhaps most importantly, the steps it recommends are achievable this year. They don’t require massive, overall tax reform, but rather common sense action by Congress on some of the least effective giveaways. The following are some of the tax spending programs that are reduced or eliminated in the president’s budget:

Cuts to oil and gas tax subsidies: $43.6 billion over 10 years. Our government spends $4 to $5 billion per year subsidizing the extremely profitable oil-and-gas industry through special tax breaks. The president’s budget cuts this wasteful spending, eliminating eight special tax breaks for oil companies.

Cuts to coal tax subsidies: $2.5 billion over 10 years. The special tax subsidies for the coal industry are smaller but similarly wasteful. President Obama’s budget cuts out four special coal tax breaks.

Cuts in tax breaks relating to inventory: $61 billion over 10 years. The president’s budget cuts special tax provisions that allow companies to choose the most favorable method for valuing their inventory and cost of goods sold. This is an inefficient and unnecessary subsidy for certain businesses.

Closing the “carried interest” loophole: $14.8 billion over 10 years. A special loophole permits the managers of hedge funds and private equity funds to pay preferential capital gains rates on much of their compensation. This special loophole results in some of the richest people in America paying lower tax rates than middle-class Americans, who pay ordinary tax rates on their wages and salaries. The president’s budget eliminates this egregious subsidy.

Limits on itemized deductions: $321.3 billion over 10 years. The tax code contains many incentives that are functionally equivalent to spending programs that promote the same activities. One of the unintended effects of these “undercover” spending programs is that they provide much bigger tax benefits to those in the highest tax brackets. For a wealthy taxpayer in the highest 35 percent tax bracket, a $100 itemized deduction is worth $35, but for a taxpayer in the lowest 10 percent bracket that same deduction is worth at most $10. President Obama’s budget reforms this inefficient and ineffective spending by limiting the value of itemized deductions for those in the highest brackets to the same tax benefit that a family in the 28 percent bracket would receive. It uses the savings to extend relief from the Alternative Minimum Tax, which would otherwise burden an increasing number of middle-class families.

The president’s FY 2012 budget also saves billions of dollars by allowing dozens of special tax subsidies to expire on schedule. (A complete list of these special tax subsidies is available on pages 149-151 of the administration’s “General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals.”)

The upshot: If congressional leaders are intent on cutting inefficient government spending, they should start by adopting the common sense cuts to tax expenditures in the president’s budget.

Seth Hanlon is the Director of Fiscal Reform for the Center for American Progress’s Doing What Works Project, and the author of a weekly series examining tax expenditures.

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