July 28, 2011
by Diana Furchtgott-Roth
A resolution of the debt ceiling stalemate may be in sight. On Wednesday, the Congressional Budget Office announced that House Speaker John Boehner's Budget Control Act, as amended, would reduce the budget deficit by $915 billion over the next decade. This opens the way for the bill to be considered on the House floor today, Thursday. A version approved by the Democratic and Republican leadership could go to the Senate over the weekend and to President Obama early next week.
At the heart of the painful negotiations over deficit reduction has been the tension between eliminating tax expenditures, namely tax breaks for individuals and businesses, and cutting tax rates. That, in turn, is an argument over raising revenue, an argument between conservatives (mostly Republicans) and liberals (mostly Democrats) about whether raising new revenue is a desirable way, combined with spending cuts, to shrink future deficits. And that is an argument about the size of government, which, generally speaking, Republicans want to reduce more than do Democrats.
Tax expenditures are the money saved by taxpayers when they avail themselves of provisions in the tax code, such as deductions for mortgage interest, state and local income and property taxes, charitable contributions, large medical expenses, casualty losses and contributions to tax-favored education and retirement accounts. Tax credits, dollar-for-dollar reductions in taxes owed, for example for electric cars or solar energy, are another form of tax expenditure.
For business, tax expenditures include accelerated depreciation schedules for machinery, expensing for business equipment, rapid write-offs for solar and wind power.
Tax expenditures exceeded $1 trillion in the government's 2010 fiscal year, which ended September 30. Some say that curtailing tax expenditures is the same as cutting spending, and that there isn't much difference between getting rid of one or another. Others disagree.
Democrats tend to say that getting rid of tax breaks should not be counted as raising taxes. Republicans take the view that any limitation on tax breaks should be paired with offsetting declines in tax rates, so as to keep revenue collections by Uncle Sam unchanged, at least in the early years. Eventually, if history is a guide, a more efficient tax system will bring in more revenue to the Treasury, as lower rates foster economic activity.
Advocates of curtailing or eliminating tax expenditures say that they are not raising taxes, because the tax rates remain the same, or fall. In my opinion, this is disingenuous if the result is that revenue collections rise. Legislated increases in revenues, whether from higher rates or reduced tax expenditures, discourage economic growth. With lower rates, economic recovery and higher employment eventually would raise the ratio of revenue to gross national product, reducing the deficit.
Consider the recommendation of Martin Feldstein, the distinguished Harvard economist and president emeritus of the National Bureau of Economic Research. Mr. Feldstein has suggested capping the benefits that taxpayers receive from tax expenditures at a particular level, perhaps two percent of adjusted gross income. Mr. Feldstein has written that limiting tax expenditures would reduce the deficit by hundreds of billions of dollars annually without raising tax rates, and so would not affect the incentive to work, to save or to expand businesses.
Mr. Feldstein says that the government can raise revenues by trillions of dollars without affecting incentives to work or invest. This makes no sense to me. In my view, the heart of the matter is this: if the government takes in more revenue, that is less for the private sector. And it is the private sector that drives economic growth.
Support for lowering rates in tandem with curtailing tax expenditures comes from many sources, including one version of the Boehner plan under discussion last week.
The Committee for a Responsible Federal Budget, a bipartisan group that includes all former Congressional Budget Office directors, said that tax expenditures "are more similar to spending than tax cuts...Reducing these 'tax earmarks' is a critical first step in fundamental tax reform since it would broaden the base and permit lower rates."
But make no mistake. Tax expenditures and government spending are different. With tax expenditures, individuals keep and control more of their money, and most Americans believe that they can make better use of it than does the government. Economists spill much ink discussing "dead-weight loss," the loss of utility of a dollar transferred from taxpayers' pockets to the Treasury.
Rather than increase tax revenues, Congress should cut spending more deeply. Eliminate proposed high-speed rail, raise gradually the Social Security retirement age and eligibility age for Medicare, repeal the new health care law, leave the slots of retiring federal workers unfilled, expand competitive bidding to all Defense Department contracts.
Higher tax bills, whether they result from curtailing tax expenditures or from higher rates, may mean that a family that can just afford to meet expenses today may not be able to afford them tomorrow. That would be bad news for the tens of millions of Americans who are struggling to work their way out of the recession.
The stakes are high, and Congress needs within days to send Mr. Obama a bill that cuts spending, shrinks further deficits, and raises the debt ceiling.
In this process, cuts in tax expenditures, both individual and corporate, need to be balanced with lower rates so that tax reform is initially revenue neutral and not a tax increase in disguise. Then a more efficient tax system will eventually generate higher tax revenues, a lower deficit, and stronger economic growth, our ultimate goal.
Diana Furchtgott-Roth, former chief economist of the U.S. Department of Labor, was a Senior Fellow at Hudson Institute from 2005 to 2011.
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