Last week, Len Burman published a provocative op-ed suggesting that President’s Obama idea of freezing non-security discretionary spending amounts to “chump change” and that if he wants to make real budget improvements the President should propose to freeze tax expenditures (i.e., all the various preferences in our famously complex tax code). By Len’s calculations, such a freeze would increase tax revenues by $3.5 trillion over the budget window, 14 times as much as the $250 billion in spending reductions from the narrow spending freeze.
Len is right to focus attention on tax expenditures. They involve big money, distort our conception of the size of government, often disproportionately favor the affluent, and receive too little oversight.
He’s also right that they deserve special attention when Congress decides that it wants to increase tax revenues. As Len says in the interview: “Cutting tax expenditures is a much better way to do this than raising marginal tax rates since the former tends to improve economic efficiency by reducing economic distortions — for example, among different kinds of investments — while the latter increases the economic cost of taxation.”
Of course, there are some complications. In addition to the obvious political challenges, tax expenditure cutters face another problem: agreeing on what provisions should actually be characterized as tax expenditures. One could, of course, just use whatever definitions the Treasury and the Joint Committee on Taxation use. But analysts do not agree on which provisions are really spending programs in disguise.
Some cases are easy. Tax credits for using ethanol-blended motor fuels are clearly spending programs run through the tax code. But then there are items like the 15% tax rate on capital gains and dividends. That rate is scored as a tax expenditure in the current system because 15% is lower than the rates on ordinary income. It wouldn’t be viewed as a tax expenditure, however, by analysts who believe that a consumption tax, rather than an income tax, should be the lodestar for judging tax policies. My point is not to take sides on that issue, but just to point out that there is sincere debate about which items labeled as tax expenditures should be viewed as hidden spending programs and which as good tax policy.
In response to one question, Len raises the idea of subjecting all tax expenditures to annual reauthorization as one way to rein them in. I appreciate the desire for greater oversight, but I find this idea worrisome. We are already cursed with a tax system in which an enormous number of provisions are scheduled to expire. That creates needless uncertainty, placing a real burden on businesses and families and often undermining the very intent of the tax provisions. As a case in point, consider the research and experimentation tax credit, which Congress extends every year or two. That’s absurd. If the credit is good policy, it should be enacted on a permanent (or, at least, prolonged) basis so that it provides a clear signal to firms that engage in R&E. Conversely, if it’s bad policy, we should kill it. Revisiting it every year will just enrich lobbyists, distract legislators from more important issues, and weaken any incentives it might create.
I expect that the same holds true for many other tax expenditures. Some deserve to be enacted for prolonged periods to accomplish their goals. Some deserve annual review. And many deserve to be killed.