A Curmudgeon's Notebook: Treat Tax Expenditures Differently

2012 May 06
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Much of the complexity of the tax code appears to be related to tax expenditures embedded in the tax code. "The Congressional Budget and Impoundment Act of 1974 (CBA) defines tax expenditures as "those revenue losses attributable to provisions of the Federal tax laws which allow a special credit, a preferential rate of tax, or a deferral of tax liability" (Surrey 1985)." Reference: Wikipedia: Tax expenditure.

Many have observed that tax expenditures do not receive the same level of review and approval as do appropriations. Consequently, many appear to be "below the radar".

The continuation of this post discusses an idea to treat tax incentives as tax credits to be applied to the tax due from baseline, or universal, taxes. The tax expenditures could then be more easily be subject to annual appropriations review, and publication of the cost of each line item in tax expenditures. Of course, the number and amount of tax expenditures should be greatly reduced.

Don Nordeen
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Treat Tax Expenditures Differently (continued)

Introduction

A major part of the complexity of the tax code are the many provisions creating tax expenditures. Each of the tax expenditures has its own beneficiaries who will argue for continuation. Further, many have small effects but taken together have significant costs. The complexity is indicated by the need for a separate The Joint Committee on Taxation. See Overview for the authorization and scope of the committee's activities. Click on Publications to view the scope of the reports produced. This webpage also provides a definition of tax expenditures.

"In general, tax expenditures include any reductions in income tax liabilities that result from special tax provisions or regulations that provide tax benefits to particular taxpayers. Importantly, a tax expenditure estimate is not the same as a revenue estimate. Unlike revenue estimates, tax expenditure estimates do not incorporate any behavioral response of taxpayers or changes in the timing of tax payments."

It is just another example that complexity begets complexity.

An excellent article on Tax Preferences has been published by The Economist which identifies the 10 categories and their amounts [1]. Perhaps a two-step process would help unravel the issue.

First, revise the tax code so that tax expenditures become tax credits to be applied after calculation of tax due from from universal simple tax-code requirements. Each tax expenditure would then be itemized to claim the tax credit, which would make the tax-expenditure amounts easier to track and summarize.
Second, make the tax expenditures into an appropriations bill which would then subject them to annual review and be a separate part of the budget. This could provide the transparency to focus attention on the scope and details of the tax expenditures. Both the vital few (those with large individual amounts) and the significant many (the many with small individual amounts but with large totals) could more easily be addressed.

There is much similarity to earmarks, which have received more attention when subjected to similar listings and appropriations.

From The high price of tax breaks: Not so easy
Closing loopholes is politically painful,
The Economist, 2012 Apr 28.

The chart at the right shows a breakdown of some of the largest tax expenditure categories. It, however, does not include the standard deduction which is currently available to all tax payers who don't have larger itemized deductions.
Before determining what actions may be appropriate for the categories in the table, decisions are needed for several general areas:

Whether or not to retain the standard deduction, or to the extent to which it should be retained. My recommendation is to eliminate the standard deduction except for a possible nominal amount to avoid have to provide detail for any small amounts.
Whether or not itemized deductions should be continued. My recommendation is to eliminate itemized deductions. Any tax expenditures that are retained to should in the form of a tax credit to avoid the regressiveness associated with deductions.
Should any personal expenditure be paid with before-tax income? No, unless there is clear justification as a benefit to the economy.

Both standard and itemized deductions are, in effect, regressive taxes, because the tax benefit is related to the marginal tax rate and increases with increasing income.
The table below provides comments on the information in table provided by The Economist.

Category	Amount, $bn	Comments
Employer health insurance	$171	Tax policy should be the same for health insurance to be paid with after-tax income. Medicare recipients pay for their Medicare supplements with after-tax income.
Capital gains and dividends	$97	• Double Taxation on Dividends should be eliminated by using the dividend deduction method in which dividends are deductible where paid and income where received. This would eliminate any unfairness related to the lower tax rate on dividends which primarily benefits the wealthy. It would also place debt and equity financing on a similar basis. Capital gains should be indexed for inflation. • Lower tax rates for capital gains and its counterpart, carried interest, should be eliminated. See Capital Gains, Economy and Income Inequality. There are no studies by either the Congressional Budget Office and the Congressional Research Service that definitively quantify a benefit to the economy from the preferential tax treatment.
401(k), IRA and self-employed pension plans	$93	Retirement saving should be encouraged. The costs and benefits should be evaluated on a net present value basis. Taxes are deferred, but are collected on the investment plus return on investment after retirement when funds are withdrawn. Further, inadequate retirement savings may burden the safety net and increase costs.
Mortgage interest	$87	To avoid shifting investments to avoid paying mortgage interest, all interest should be deductible where paid and income where received. See Retain Mortgage Interest Deduction.
Employer Pension plans	$44	The costs and benefits should be evaluated on a net present value basis. Taxes are deferred, but are collected on the investment plus return on investment after retirement when funds are withdrawn.
Deferral of tax on foreign profits	$42	Make the tax policy competitive with the policies of other countries.
Charitable contributions	$33	Eliminate deduction.
State and local taxes	$33	Eliminate deduction.
Municipal bond interest	$29	The current tax policy favors the wealthy since they are the primary investors are wealthy and may pay a high marginal rate. Should the federal government subsidize municipal governments? To avoid any disproportional benefit to the wealthy, any tax preference should be in the form of a tax credit as a percentage of the interest.

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Endnotes

[1] Anonymous, The high price of tax breaks: Not so easy - Closing loopholes is politically painful, The Economist, 2012 Apr 28, http://www.economist.com/node/21553473, (accessed 2012 May 01).

History: Changes are usually identified in the text with the date which facilitates searching by date. Edits are usually noted by add and ~~delete~~ changes.

2012 May 06 — Initial Post

Links: Treat Tax Expenditures Differently at [http://curntbk.blogspot.com/2012/03/treat-tax-expenditures-differently.html]

A Curmudgeon's Notebook

May 6, 2012

Treat Tax Expenditures Differently

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