Here is another proposal for how to cut the deficit. This one suffers from a toxic premise:
There is a way to cut budget deficits without raising tax rates. “Tax expenditures” are the special features of U.S. income tax law that subsidize mortgage borrowing, health insurance, local government spending and more. Although these subsidies are a form of government spending, they are counted as reduced tax revenue rather than increased government outlays. Yet tax expenditures increase the deficit by hundreds of billions of dollars a year, more than the total cost of all non-defense programs other than Social Security and Medicare.
A critical feature of the proposal recently unveiled by Erskine Bowles and Alan Simpson, the co-chairmen of the president’s bipartisan fiscal commission, is to reduce tax expenditures rather than raise tax rates. That would increase revenue without reducing incentives to work, save or invest.
Their most extreme suggestion is to eliminate all tax expenditures, raising $1 trillion a year in additional tax revenue, and then use all but $80 billion of that to cut tax rates. I think that devotes too little money to deficit reduction at a time when fiscal deficits are dangerously large.
Because Bowles and Simpson recognize that eliminating all tax expenditures is politically impossible, they also proposed to eliminate or scale back some tax expenditures while cutting tax rates less to achieve the same $80 billion annual deficit reduction. This option will undoubtedly be opposed by some who find it unfair to limit measures from which they benefit while leaving unchanged tax rules that benefit other people.
Here is a practical alternative toward the same end: Congress should cap the total benefit taxpayers can receive from the combined effect of different tax expenditures. That cap could be set as a percentage of an individual’s adjusted gross income and perhaps subject to an absolute dollar amount.
To be clear, the cap would not apply to the amount of any deduction but would limit the total tax savings that result from such deductions. Someone with a 25 percent marginal tax rate who pays annual mortgage interest of $4,000 would still deduct that $4,000. The cap would apply to the $1,000 tax saving that individual could expect on mortgage interest, not to his or her deduction.
The idea is not to single out a particular tax expenditure. Because the cap would reduce the revenue cost of all tax expenditures without eliminating or reducing specific ones, it would not unfairly burden taxpayers who benefit from one particular type of tax measure.
The budget gain would be substantial. My colleague Daniel Feenberg of the National Bureau of Economic Research and I have estimated that capping an individual’s benefit from tax expenditures at 2 percent of adjusted gross income would reduce the federal deficit in 2011 by $262 billion, or about 1.7 percent of gross domestic product. An additional cap on these benefits in absolute dollar terms would produce a larger deficit reduction. . . .
The tax expenditures subject to the cap in our calculations reflect deductions for mortgage interest, state and local income and property taxes, and charitable contributions; credits for dependent care, children and certain education costs; and the exclusion of employer payments for health insurance. Congress could, of course, expand or reduce this list. Dropping the deduction for charitable contributions, for example, would reduce the 2011 revenue gain by some $45 billion.
More than 65 percent of taxpayers do not itemize their deductible expenses but use the standard deduction. Nearly half (46 percent) of taxpayers who use the standard deduction would not be affected by a 2 percent cap. For those who are, the cap would apply to various tax credits and to the exclusion of employer payments for health insurance.
Doesn’t this assume that all money belongs to the government? So not taking a person’s money counts as an “expenditure”? It also says that taxing something that was not taxed before somehow avoids a tax increase.
If you can get past those problems, what do you think of this idea? Capping deductions might be better than eliminating them entirely, as some are proposing. But decreasing the mortgage deduction certainly won’t help the housing market–which is necessary for non-government economic growth–nor will cutting back charitable deductions help churches and other private groups step in with the safety nets that government budget-cutting will be eliminating.