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The Wyden-Gregg Bipartisan Tax Reform Plan: A Familiar Pattern

February 23rd, 2010 . by economistmom

gregg and wyden hearing

I do like that Senators Wyden (D-OR) and Gregg (R-NH) have worked together in a bipartisan manner to come up with a tax reform plan that lives up to the term “reform” (as in “improvement”) by actually broadening the tax base and eliminating some tax expenditures that seem to have little economic justification.  But a read through their own op-ed in today’s Wall Street Journal suggests how they chose which particular tax expenditures to eliminate and which to keep (emphasis added):

By streamlining and modernizing the outdated tax code, our proposal would eliminate many of the specialized tax breaks that currently benefit one group of Americans over another. The changes we propose will create policies that benefit everyone. They include: fiscally responsible middle-class tax cuts, business tax breaks to help American companies compete globally and create jobs, and a fairer and simpler tax system for all Americans…

We make fiscally responsible tax reform possible by eliminating many of the specialized tax breaks strewn throughout the tax code. Our legislation maintains the most popular tax breaks like the mortgage interest deduction and the health-care tax exclusion, while eliminating specialized exemptions such as a company’s ability to deduct as a business expense punitive damages resulting from lawsuits.

Our legislation also eliminates tax incentives that encourage American businesses to keep more of their foreign earnings overseas and export jobs by repealing the rule that allows U.S. companies to defer taxes on foreign income. And we take a hard line on corporate welfare by directing the Congressional Budget Office to examine the roughly $90 billion that the federal government spends to subsidize businesses directly and indirectly each year. These steps not only make the tax code simpler and fairer for everyone, they reduce opportunities for individuals and businesses to cheat the system and avoid paying their fair share…

The pattern is familiar:  even in base-broadening tax reform, avoid raising taxes on “real people” and instead reduce tax preferences that currently benefit “evil corporations”–or otherwise attack things that seem to fall under the “waste, fraud, and abuse” category.  Note that the proposal only directs CBO to “examine” tax expenditures, and only the corporate ones at that.  Wyden and Gregg make a point of preserving the “most popular” tax expenditures and specifically point out their keeping the mortgage interest deduction and the health-care exclusion.  Just because these are “popular” doesn’t mean they’re (economically) “smart.”  The two examples touted are in fact the two single largest tax expenditures in the federal budget–the mortgage interest deduction costing more than $100 billion per year, and the health care exclusion more than $150 billion per year (each more than the value of all corporate tax expenditures combined).  Eliminating the health care exclusion alone would be enough to get the 2015 deficit down to the Administration’s goal of 3 percent of GDP and would promote greater efficiency in the health care market by bringing out of pocket prices more in line with the true cost of health care (thus helping to damp down excess demand and ultimately bring down health costs).  But any good politician would ask:  why would we want to do that if it means so obviously raising taxes on real people–even if it would work to reduce health costs over time?…

And that’s why it’s hard to be popular and smart at the same time.  And if politicians propose a “bipartisan” tax reform plan you can be sure it looks like it gives more away than it takes and probably doesn’t do as much to truly “reform” the tax system as is advertised.  The Wyden-Gregg proposal is a step in the right direction, but it’s not that bold a change and doesn’t really make any tough choices.  It’s a familiar pattern.

37 Responses to “The Wyden-Gregg Bipartisan Tax Reform Plan: A Familiar Pattern”

  1. comment number 1 by: Brooks

    Diane,

    FWIW (in case you missed it), I’ll repeat my suggestion at http://economistmom.com/2010/02/is-the-obama-budget-half-full-or-half-empty/#comment-6670 Granted, it would be a tough challenge to get people to understand that tax expenditure subsidies are exactly the same as “spending” subsidies in everything but name, and very different from tax rate cuts, but IMHO it could be worthwhile to try per the video I suggest at that link.

  2. comment number 2 by: SteveinCH

    Diane,

    I’m really surprised by the tone of your post. I compare it to your post on PAYGO and frankly I’m puzzled. Yes, the Wyden/Gregg proposal is a half a loaf or less but it’s better than where we are. Why doesn’t the logic applied to the PAYGO law (which can’t even be called swiss cheese it has so many holes) apply here?

    To Brooks, I smiled when I read your post and I won’t replay our 100-post discussion of tax expenditures : ) other than to say that I don’t think what you propose is doable.

    Sure, you could raise taxes a lot more by eliminating more deductions and, potentially, you could lower rates more if you wanted to do that to offset. Remember though, that the current deduction system, regardless of what the President may claim, actually makes the system more “progressive”, a favorite of the majority party in Congress. Many deduction and exemptions are flat dollar which clearly has a progressive impact. Furthermore, for the evil rich the deductions phase out with income, another progressive element of the tax exemption regime.

    The problem with changing the regime in any way is that there are winners and losers and politicians can’t stomach losers that are potentially politically popular.

  3. comment number 3 by: Brooks

    Steve,

    That makes two of us re: replaying that discussion ;) but as for the extent of political feasibility of reducing/eliminating tax expenditure subsidies and inhibiting their expansion and creation of new ones, all I’m saying is that we should try to get the public to see them for what they are — the same as “spending” subsidies and different from tax rate cuts — and consider and debate them on that basis. I definitely think (and our previous discussion shows) that such a shift in how people view them (from conceptually incorrect to conceptually correct) would make a substantial difference, most notably by reducing their attractiveness among the right and center. After all, as I’ve said before, don’t you think that there would be more acceptance (and even some enthusiasm) on the right for Obama’s SOTU speech as is…

    we … made health insurance 65 percent cheaper for families who get their coverage through COBRA; and passed 25 different tax cuts.

    Now, let me repeat: We cut taxes. We cut taxes for 95 percent of working families. (Applause.) … We cut taxes for first-time homebuyers. We cut taxes for parents trying to care for their children. We cut taxes for 8 million Americans paying for college. (Applause.)

    [Obama looks at Congressional Republicans and says to them] I thought I’d get some applause on that one. (Laughter and applause.)

    …than for this translation:

    we … borrowed and spent more to provide subsidies to make health insurance 65 percent cheaper for families who get their coverage through COBRA; and passed [almost] 25 different increases in deficit-financed spending subsidies.

    Now, let me repeat: We increased borrowing so we could increase spending subsidies. We increased borrowing so we could increase spending subsidies for 95 percent of working families. (Applause.) … We increased borrowing so we could increase spending on subsidies for first-time homebuyers. We increased borrowing so we could increase spending on subsidies for parents trying to care for their children. We increased borrowing so we could increase spending on subsidies for 8 million Americans paying for college. (Applause.)

    [Obama looks at Congressional Republicans and says to them] I thought I’d get some applause on that one. (Laughter and applause.)

    Again, I am by no means saying that taking away the mortgage interest deduction or the health insurance exemption would be anything anywhere close to easy, but in general the more tax expenditure subsidies are seen for what they are rather than as more similar to tax rate cuts than “spending”, the less we are likely to have of them.

  4. comment number 4 by: SteveinCH

    And Brooks, I’ll maintain that a reduction in tax expenditures is an increase in the amount of money the government takes from the people all things being equal to my dying breath.

    It’s back to a debate about the size of government versus balancing the budget.

    Imagine I eliminated all tax subsidies and refunded the money in exact amounts so that nothing changed from a deficit perspective. You would maintain that nothing has changed. I would assert that the government is now larger than it ever has been and we the people have endorsed a government larger than at any time in the historical past.

    That’s why we’ll never get past the debate because I fundamentally care about how much money government spends in addition to the deficit. I won’t comment on whether you do or not but a government that is 29 percent of GDP is, for me, worse than one that is 25 percent, assuming equivalent deficits (as a percent of GDP) in each case. Would I extend that analogy to say that zero percent is the best answer? No. But I don’t think we’re in any danger of crossing my personal minimum any time in my lifetime.

    It goes back to something I’ve said to Diane a few times. In the end, I believe in limited government which to me means that government should do only what it must, recognizing that there are many things it could do, even some of which might be good, that it must not do. For once you decide that government should do everything it can, you have given government too much power and control over the lives of the citizens.

    Imagine a world where we believed that government should only provide for those who demonstrably cannot provide for themselves. We would have a very different looking government, and a much smaller one.

  5. comment number 5 by: Lida

    Diane,
    Thanks for again pointing out that if it seems to good to be true, it is. However, I think you should give Senator Wyden more credit because in his “Healthy Americans Act”, he does call for the move to tax employer provided health benefits. This was another bipartisan bill co-authored by Senator Bob Bennett of Utah. According to an article in today’s NY Times, Senator Gregg recently spoke favorably of the Wyden/Bennett bill, so there may be hope that they would agree to propose eliminating the health insurance exemption.

  6. comment number 6 by: Brooks

    Steve,

    I don’t think either of us wants to replay that long discussion, but I must say that you are still fundamentally misunderstanding this matter and erroneously viewing it as somehow related to one’s ideology — one’s view of the appropriate size and role of government — and also misunderstanding the equivalence I’m asserting. As I said on the other thread, it is not simply deficit-neutrality, it’s equivalence to “spending” subsidies in everything but name and official categorization and bookkeeping — the same in government-provided incentives, economic effects, everyone’s income statement and balance sheet, etc., and all on the same basis as an explicit “spending” subsidy, and all of the above clearly different from a tax rate cut. But I think I ran out of ways to explain and illustrate it on that 111 comment thread. I think the fact that someone as intelligent as you still does not understand just highlights the challenge of communicating this point and correcting the misconception.

  7. comment number 7 by: SteveinCH

    No worries Brooks. Just wanted to say that explaining it is likely more difficult than you give it credit for.

  8. comment number 8 by: Brooks

    Oh, I appreciate the difficulty in explaining it. As I said in my initial comment, “Granted, it would be a tough challenge to get people to understand…”

    In any case, I assume you agree that, for the most part and assuming revenue-neutrality, it is more efficient and economically beneficial (and less prone to adverse manipulation to serve special interests) to have a simpler tax code without a large degree of tax expenditure subsidies, and that there may be exceptions in which it’s worth it to reward choices/activities with positive externalities or to tweak the tax code to make it “fairer”, but those would be exceptions rather than the rule.

  9. comment number 9 by: SteveinCH

    I do agree with that Brooks, however, i strongly suspect that most people who promote the notion of neutrality between tax expenditures and actual expenditures have in mind a solution that is not revenue neutral.

    If I had my way, there would be no exceptions in the tax code of any type and we’d set the rates necessary to collect the money we decide we need. I don’t think I’ll see that in my lifetime but one can always hope.

    Back to my original point, it seems Wyden-Gregg is more of a step in the right direction than statutory PAYGO hence my confusion about the different line Diane took in her two posts

  10. comment number 10 by: Brooks

    I do agree with that Brooks, however, i strongly suspect that most people who promote the notion of neutrality between tax expenditures and actual expenditures have in mind a solution that is not revenue neutral.

    Perhaps, but there are certainly plenty of conservative economists and other conservatives who favor a simpler tax code with a much lesser presence of tax expenditure subsidies. In any case, your statement is the equivalent of saying that most people who favor cuts in particular “spending” subsidies do not have in mind using the savings for tax cuts (rather, they have in mind using those savings for either deficit reduction or incremental spending in some other area). Someone who wants “smaller government” should favor reduction/elimination of tax expenditure subsidies even without offsetting tax rate cuts. Yes, government would then receive more revenue, but the direct effect would be the equivalent of lower “spending” and less government interference in the economy and micromanagement of individual choices, and to whatever extent the incremental revenues are used for incremental (explicit) spending, that would be the equivalent of using savings from reductions in “spending” subsidies to “fund” incremental (explicit) spending, not the equivalent of raising tax rates to fund incremental spending. But I guess we’re covering old ground because the above relates to my explanations of equivalence and distinctions that you don’t think are valid.

    Re: one’s opinion of Wyden-Gregg vs. that version of PAYGO, it is not necessarily a contradiction for one to consider some very imperfect policy as better than nothing in the sense of movement in the right direction and/or “not letting the perfect be the enemy of the good”, and to consider another very imperfect policy as so inadequate that it does more harm than good in terms of opportunity cost — reducing the chances of something better. That said, it is certainly legitimate to question the discrepancy as you have.

  11. comment number 11 by: SteveinCH

    Brooks,

    Without replaying our argument (which we are at the risk of doing), you write, “Someone who wants smaller government should favor reduction/elimination of tax expenditure subsidies even without offsetting tax rate cuts.” Whether they should or not entirely depends on what the government does with the increased revenue. For example, say the government eliminated the mortgage deduction and used the hundreds of billions of dollars generated to set up a new regulatory authority that managed how individual households set their thermostats and the time and speed at which they drove their cars.

    I would be starkly opposed regardless of the financial impact. It’s not just about financial equivalence.

  12. comment number 12 by: SteveinCH

    On Wyden-Gregg, I guess I’m just making the point that unlike statutory PAYGO, Wyden-Gregg makes no pretenses of “solving” the problem. It’s simply a better solution than the one we have today. It provides no political cover like PAYGO and, at least so far, it is not being set up as some panacea that means we don’t have to worry about the deficit anymore.

    I agree you can make the distinction, it just seems to me that the distinction would actually run in the opposite direction.

  13. comment number 13 by: Jim Glass

    Imagine I eliminated all tax subsidies and refunded the money in exact amounts so that nothing changed from a deficit perspective. You would maintain that nothing has changed. I would assert that the government is now larger than it ever has been

    Refunded? As in through other tax subsidies? Well, that wouldn’t be progress.

    Instead, eliminate all tax sudsidies and reduce tax rates across-the-board accordingly.

    Now government becomes smaller in two ways:

    1) With subsidies eliminated, the politicians are no longer using them to directly intervene to favor/punish particular parts of the economy for political purposes.

    2) With lower tax rates, the *deadweight cost of taxes*, the true cost of taxes, is reduced. Remember, the deadweight cost of taxes increases by the *square* of the rise in the tax rate, reducing GDP accordingly.

    Even if the *same amount* of tax is collected, using a higher tax rate reduces GDP while using a lower tax rate increases GDP.

    Now, the same amount of tax with smaller GDP is “bigger government”, while with bigger GDP is “smaller government”, I think you will agree.

    When one goes handing out subsidies one must increase tax rates to compensate, to collect the same amount of revenue. (Even if you deficit finance, remember.) So one increases the size of the government, even as defined as taxes/GDP. And, of course, one obviously increases the direct intervertion of politicans in the economy — increasing the size and power of govt. Two ways the govt is made bigger.

    Reducing subsidies and lowering tax rates accordingly does the reverse, reducing the size of govt in two ways.

    That’s what the Tax Reform Act of ‘86 did with great success — which is why so many governments around the world copied it, and still are, by broadening tax bases and reducing tax rates.

  14. comment number 14 by: SteveinCH

    Jim,

    I meant refunded through direct payments rather than through other subsidies. I agree with your pov that eliminating subsidies and balance with rates is the proper way to think about this. As we learned in 100 post extravaganza, we are not all aligned on that pov and I don’t want to reopen it.

  15. comment number 15 by: Jim Glass

    … I think I ran out of ways to explain and illustrate it on that 111 comment thread….

    Perhaps a numerical example will help.

    I’ve simplified for illustrative purposes, but this shows the process at work via rates, tax expenditures, deadweight cost of taxes…

    Initial position…

    Taxpayers: 1,000
    Income: $10,000 each
    GDP: $10 million
    Govt expenditures: $3 million
    Tax collected: $3 million
    Tax collected per taxpayer: $3,000
    Tax rate: 30% flat tax
    Deeadweight cost of taxes: 2.0, i.e, $2 for every $1 of tax collected.

    Now, “tax breaks” are enacted by politicians for favored constituents, allowing 20% of taxpayers “to keep their own money” and pay zero tax. (No change is made to the govt’s spending.)

    Consequences …

    Taxpayers: 800
    Tax collected: $3 million
    Tax collected per taxpayer: $3,750
    Tax rate: 37.5% (up 25% from 30%)
    Deadweight cost of taxes (DWC): $3.125 per $1 of tax collected (1.25^2 x 2.0)

    Netting DWC …

    Reduced DWC for newly tax exempt: - $1.2 million (2.0 x 200 x 3,000 tax reduction)
    Increased DWC from rate increase: + $3.375 million ([3.125 - 2] x 3 million)
    Net increase in DWC: $2.175 million.

    Adjusting GDP…

    $10 million initial
    - $2.175 million increase in deadweight cost of taxes
    = $7.825 million final GDP

    Adjusting “size of government”…

    Inital: 30% of GDP ($3 million / $10 million)
    Final: 38.3% of GDP ($3 million / $7.825 million)

    Adjusting GDP per capita…

    Initial: $10,000
    Final: $7,825, down 22.75%

    Thus we see the results of collecting any given amount of revenue by using a “many tax preferences + higher rates” structure versus a “no tax preferences + lower rates” structure — and why it is a really good idea to go from the former to the latter.
    ~~~

    (Note well: Using deficit finance — in this example choosing to run a $600,000 deficit and keeping the tax rate at 30% instead of increasing it to 37.5% — does not help for reasons I’ve explained elsewhere. In the long run, it only makes things worse.)

  16. comment number 16 by: Brooks

    Steve,

    Re: say the government eliminated the mortgage deduction and used the hundreds of billions of dollars generated to set up a new regulatory authority

    My point is that eliminating that mortgage interest subsidy would be the same whether the subsidy were provided via tax deduction or via a check the government sent you in the mail (aside from any timing differences). The latter would be called “spending” and you’d view it very differently even though the two are exactly the same in every substantive way. So whatever you would think of government eliminating a “spending” subsidy for mortgage interest payments (sent in the form of a government check, such as a voucher), given the the likelihood and desirability/undesirability of government then using the incremental funds to set up and spend incremental money on some new regulatory authority, that’s exactly how you should think of elimination of the subsidy that is provided via tax deduction (other than the politics of it, which I have argued would make elimination of the tax expenditure form of the subsidy more desirable than the explicit “spending” form*).

    Whether government eliminates an “implicit spending” (tax expenditure) subsidy for mortgage interest payments or eliminates an equivalent explicit “spending” subsidy, it could use the incremental funds for either (1) incremental spending (implicit or explicit), (2) tax rate cuts, or (3) deficit reduction, but the form of the subsidy (tax expenditure vs. explicit “spending”) is irrelevant to how one should view that policy change (again, other than the politics). Put differently, given whatever probabilities you assign to various degrees of the extra funds being used for #1, #2, and/or #3 above, if you would oppose an equivalent subsidy in explicit “spending” form, you should oppose the subsidy in tax expenditure form just as much in terms of substance (i.e., aside from the politics), and I’d argue (as would I think most political observers) that the politics makes the tax expenditure form less desirable / more undesirable.

    As I stated upthread: To whatever extent the incremental revenues [from reducing/eliminating a tax expenditure subsidy] are used for incremental (explicit) spending, that would be the equivalent of using savings from reductions in “spending” subsidies to “fund” incremental (explicit) spending, not the equivalent of raising tax rates to fund incremental spending.

    * Essentially because of (1) the misconception people so many people have (the misconception I’m trying to explain to you), (2) the tax expenditure form is less transparent, (3) tax expenditures are treated as an entitlement rather than reviewed annually as part of the discretionary budget, and because of all of the above, tax expenditures are more likely to be created/expanded/maintained and less likely to reflect the priorities of the public)

  17. comment number 17 by: SteveinCH

    Brooks,

    I apologize but I’m not going to engage on the substance again. I appreciate the attempt but it still doesn’t work for me.

    Thanks for trying

  18. comment number 18 by: Brooks

    Jim,

    I just want to make sure we are clearly distinguishing between two different matters before us:

    (1) The fact that, politics aside, (A) tax expenditure subsidies are no different from their equivalent explicit “spending” subsidies in any way but name and bookkeeping (same incentives, same economic effects (assuming a rational view of each relative to the other), same financial affects on all involved and on the same basis), and (B) tax expenditure subsidies ARE substantively very different from tax rate cuts in terms of incentives, economic effects, financial effects on all involved and basis for those effects.

    (2) It’s generally preferable to have fewer tax expenditures and lower tax rates (A) from an economic perspective and (B) from a political perspective (see my asterisk in comment above).

    I was discussing #1 with Steve. Your illustration seems to pertain to #2. I’m not discounting its value at all, just pointing out the distinction lest there be conflation of the two and resulting confusion.

  19. comment number 19 by: Brooks

    Steve,

    ok. No need to apologize. We spend quite a bit of time on it previously.

  20. comment number 20 by: Brooks

    On a lighter note, I see that Dick Durbin was selected by Reid to serve on the fiscal commission, and my question to you guys is: Am I the only guy who can’t hear “Dick Durbin” without thinking of “Dirk Diggler”?

  21. comment number 21 by: SteveinCH

    Careful, that’s my only senator you’re talking about there

  22. comment number 22 by: Brooks

    Dirk Diggler is a U.S. senator now? Wow, versatile guy!

  23. comment number 23 by: Brooks

    Seriously, I know almost nothing about Durbin, but I like his action re: the Fair Elections Now Act http://www.publicampaign.org/node/38166 Kudos for that. A good step in the right direction on a very important issue.

  24. comment number 24 by: SteveinCH

    Haha, I was more referring to the fact that almost nobody could consider Roland Burris an actual senator.

  25. comment number 25 by: Brooks

    Oh, I got that. Ridiculous that he took the seat under those conditions.

  26. comment number 26 by: Jim Glass

    I just want to make sure we are clearly distinguishing between two different matters before us…

    Brooks, your (1) and (2) are the same thing looked at from different angles.

    As tax expenditures are the equivalent of payment expenditures by their effect on deficits, on tax rates needed for net revenue, etc., increasing them necessarily requires, for any given level of revenues, higher tax rates on a narrower base — while reducing them results in lower tax rates on a broader base.

    The fact that higher taxes on a narrower base by itself is damaging, even when collecting the same amount of revenue, is why high taxes and high government spending is harmful to the economy in general, and why high tax rates driven by a plethora of tax expenditures is damanging in particular.

    I mean, if they weren’t damaging, who would care about them? Or about the equivalence between cash and tax expenditures?

    And I’ve heard many claim they aren’t damaging.

    On the left they say: “So what if we raise taxes for bigger cash expenditures? No money disappears from the economy, the tax money is just spent somewhere else by the govt instead of by the taxpayer, so total spending is unchanged”.

    But money does disappear from the economy, due to the deadweight cost of taxes. And as tax rates increase, it disappears at an exponentially increasing rate.

    On the right they say: “So what if we give our favorite interests deductions? It just lets them keep their own money. No money disappears from the economy. (In fact if we deficit finance it actually shrinks the government because taxes go down.)”

    But since we know tax expenditures = cash expenditures, we know this is false. Money does disappear from the economy. If tax rates are increased currently, to maintain the fiscal position, there you are. (And if deficit finance is used it doesn’t matter because the govt still has to collect the same amount of tax to service the debt, so the tax increase is only em>deferred. As Barrow recently said, estimating the “tax multiplier” to be negative 1.1 — increasing taxes by $100x reduces GDP by $110x, it doesn’t matter if you do it now to keep a balanced budget or later through debt service).

    So it’s all the same thing.

    And this is why the Wyden-Gregg proposal to reduce tax expenditures to lower the top corporate Rate To 24%, and keeo the top personal rate past 35%, is a good thing.

    After TRA ‘86 reduced the top rate to 28% on a deficit neutral basis most of the world followed the same policy — even Sweden did. But we’ve forgotten the lesson. Our corporate rates now are among the worlds highest, our personal rates have risen and many want to keep them going up way higher … 70%, 90%!

    Low rates are important. Tax expenditures necessarily increase tax rates unless spending is offsetting amount, just as cash expenditures do.

    Feldstein estimates the deadweight cost of income taxes at 76 cents — so GDP declines by $0.76 per dollar of tax revenue — currently, and rising from there as rates do.

    So (1) and (2) are discussions of the same thing, looking at different aspects of it. But if (2) weren’t true there’d be little reason to be concerned about (1). Given that (1) is true, we know that tax expenditures produce the same economic cost as cash expenditures via (2).

  27. comment number 27 by: Brooks

    Jim,

    My #1 and #2 are clearly not the same thing (looked at from different angles or otherwise). They are clearly distinct and it’s important to avoid conflating them if each is to have the best chance of being explained to someone successfully.

    #2 addresses the question of preferences: to what extent lower tax rates are preferable to higher tax rates with more subsidies (whether in the form of tax expenditures or explicit spending), and #1 simply makes the point that regardless of one’s preference re: #2 (or as one is developing his preference) it should make no difference to him (other than consideration of the politics resulting from misconceptions) whether a given subsidy or group of subsidies take the tax expenditure form or explicit spending form, whereas many on the center and right (including Steve) incorrectly view a subsidy in tax expenditure form more favorably than they would view the same subsidy in explicit spending form simply because of the inconsequential difference in cash flow (even though everything ends up the same and on the same basis), and they incorrectly see some ideological difference between the two (re: the size/scope/role of government). #1 is simply a correcting of a misunderstanding akin to faulty logic. #2 is a policy argument, based on economics and ideology.

  28. comment number 28 by: Jim Glass

    Brooks, I’m not going to go 109 posts on this, but as it seems clear enough, there shouldn’t be need to.

    More tax ependitures = smaller tax base, higher rates (for any fixed level of govt expenditure), *definitionally*.

    Higher tax rates = increased deadweight cost of taxes, *definitionally*. There is no “preference” about it. It is a theorem of public finance confirmed by mountains of data. It is not “based on ideology” any more than the law of gravity is.

    Cash expenditures = tax expenditures, *definitionally*, by your definition with which I basically agree.

    Ergo:

    More cash expenditures = more tax expenditures = higher tax rates = increased deadweight cost of taxes to the economy, *definitionally*.

    One can’t separate them. You can’t break up the chain. The words between the “=” signs are all part of the same thing.

    A related “preference” would be, for instance: “Even though this cash/tax expenditure *necessarily* increases tax rates and the deadweight cost of taxes on the economy, reducing GDP overall, I want it, I prefer that it be enacted, because it is *for me*, and I want mine, to heck with GDP and everybody else.”

    Or alternatively: “Because this cash/tax expenditure *necessarily* increases tax rates and the deadweight cost of taxes on the economy, reducing GDP overall, I prefer that it be repealed. (After all, it only benefits someone else, not me!) So I support Wyden-Gregg.”

    Or: “Even though this cash/tax expenditure *necessarily* increases tax rates and the deadweight cost of taxes on the economy, reducing GDP overall, I want it, I prefer that it be enacted, because in my opinion it will provide some benefit that more than offsets the deadweight-cost-of-taxes cost.”

    Higher cash expenditures = higher tax expenditures –> higher tax rates –> increased deadweight cost of taxes is *a fact*.

    Whether one cares about the higher deadweight cost of taxes or not relative what one thinks of the merits of the cash/tax expenditure is the preference.

  29. comment number 29 by: AMTbuff

    The term tax expenditure requires agreement on what constitutes income. For example, suppose that the government were to declare that every person receives $100,000 annually in imputed income for the privileges of citizenship. Failing to tax that income would be a tax expenditure. Mathematically, failing to tax the imputed income is the same as a giveaway program.

    The difference, obviously, is that the imputed income in this example is fictional, and that allowing it to be excluded from taxable income is necessary if one is to correctly measure income.

    My biggest beef with the tax expenditure folks is their complete failure to recognize that some tax breaks are in place to provide a more equitable measure of income, what wonks call horizontal equity. Take away those breaks and you are intentionally mismeasuring income, regardless of what you do to the rates.

  30. comment number 30 by: Brooks

    Jim,

    Wrong. Perhaps you’re not really reading what I’m writing. Again, one establishes the equivalence of two forms of essentially the same policy — subsidies, and the other addresses the extent to which subsidies are desirable. I’ve now given you this short version of the distinction and my prior, longer version. I agree that if you still don’t understand what I’m saying there’s probably no point in continuing this meta discussion.

  31. comment number 31 by: Brooks

    AMT,

    Re: the semantics and the conceptual distinction between tax expenditures and the absence of some potential taxation per tax rates applied to income, I’ve started using the term “tax expenditure subsidies” rather than just “tax expenditures” to hopefully make the distinction clear. At least for the most part, tax expenditures are subsidies — they incentivize particular choices or compensate for conditions generally related to choices of one sort or another, and in that sense they are (1) substantively equivalent to spending subsidies that do the same thing (they provide the same incentives, affect everyone involved the same way on the same basis, etc.), and (2) substantively very different from the absence of some potential tax on income (provide different incentives, affect different people differently, etc.).

    Re: My biggest beef with the tax expenditure folks is their complete failure to recognize that some tax breaks are in place to provide a more equitable measure of income, what wonks call horizontal equity.

    I consider myself one of those “tax expenditure folks” and I quite readily acknowledge that some subsidies — whether in the form of tax expenditures or explicit “spending” subsidies — make fiscal policy “fairer” than it would be if those subsidies were eliminated (whether or not that change were offset with tax rate reductions). But the desirability/undesirability of subsidies has nothing to do with which form they take. The questions are (1) to what extent, in general, we want subsidies in our fiscal policy? and (2) are there exceptions to our general preference — for purposes of “fairness”, economics, positive externalities, etc.

  32. comment number 32 by: Brooks

    AMT,

    Just to amend my comment above, when I say “the desirability/undesirability of subsidies has nothing to do with which form they take”, I mean that there is no substantive difference. As I’ve noted previously, One certainly may think one is better/worse than the other because of the different political treatment each receives due mainly to a failure among much of the public to see that there is no substantive difference. And for reasons I’ve given, I think subsidies in tax expenditure form are worse than their equivalent in explicit “spending” form, foremost among the reasons that the former are more likely to be created/grown/maintained than are the latter due to the aforementioned misconception and to the lesser review and scrutiny the former receives in the budgeting process.

  33. comment number 33 by: AMTbuff

    Here’s a more realistic example. Joe the Plumber wins the lottery and collects $1M in cash. An armed robber follows him and steals it. Joe gets a deduction for the theft loss, erasing almost all his tax liability on the $1M. Is this a tax expenditure?

    I say it is not. I say it is simply a fair and proper method of computing the amount of income that should rightfully be subject to tax. Income that you didn’t receive or that was stolen from you is not income that is available for paying taxes.

    Yet I’ll bet that every list of tax expenditures includes the casualty and theft loss deduction. That’s why I believe that the “tax expenditure folks” are using far too expansive a definition. If they limited it to refundable tax credits we’d be in full agreement.

    Incidentally, one of the largest tax expenditures in most lists is the exclusion of imputed rental value of owner-occupied housing. That’s one I agree with, because there is real economic income there, even if it’s not cash income. However you can’t count this as a tax expenditure if you are already counting the mortgage interest deduction. (The mortgage interest is an expense of producing the imputed rental value.)

  34. comment number 34 by: Brooks

    AMT,

    First, whatever provisions you are representing via that analogy (and please give examples — what is it a “more realistic” representation of?), would you agree that those provisions (1) represent a very small fraction of the dollar amount of total tax expenditures and (2) are fundamentally different in nature than the bulk of tax expenditures, meaning tax expenditure subsidies that essentially incentivize/reward/compensate for consumer and life choices (and in some cases situations related to choices)? I’m talking about the mortgage interest payment deduction, the tax exemption of compensation received in the form of health insurance benefits rather than cash, having a child (or another child), etc., which I think constitute the bulk of the dollars we’re talking about. Your analogy doesn’t seem to apply to them.

    Second, your question regarding what to call this potentially gray area seems to be largely an insignificant matter of semantics. Policy-makers are not deciding (nor are sensible advocates suggesting they decide) all-or-none on everything that gets officially called a tax expenditure, let alone decide on an all-or-none that lumps in every loss or use of funds other than the most obvious, conventional business expenses. Again, the point is subsidies: to what extent should we provide subsidies for what choices and situations, whether those subsidies are provided in the form of tax expenditures or explicit “spending” subsidies (as we’ve established, there is no substantive difference between the two). Obviously there is a conceptual difference between providing a subsidy and allowing a particular use/loss of funds as a legitimate business expense. But we have to look at each type of expense and decide if we want the tax code to allow it as a legitimate business expense (i.e., a reduction in net income), and we have to look at each major subsidy (or potential subsidy) and decide if we want to create/increase/maintain/reduce/eliminate it. What to call some relatively small gray area (”tax expenditure” or not) doesn’t seem all that important, and again, I think it’s useful to speak of “tax expenditure subsidies” if that’s what we’re really talking about.

    Re: I believe that the “tax expenditure folks” are using far too expansive a definition. If they limited it to refundable tax credits we’d be in full agreement.

    Wow, that is REALLY throwing out the baby with the bathwater. Of course, you’re not spelling out exactly for what purpose “the tax expenditure folks” are attaching that label, which gets back to the this matter of all-or-none (as well as business expense vs. subsidy). But in any case, you seem to be suggesting that rather than call a subsidy to buy a spade “a subsidy to buy a spade” and treat the same subsidy equally in terms of (1) seeing this subsidy as equally attractive/unattractive (substantively speaking) whether in the form of tax expenditure or explicit “spending” (rather than viewing the tax expenditure form of the same subsidy as more attractive or less unattractive even though there is no substantive difference), and (2) subjecting this subsidy to the same budget process and related scrutiny and political accountability if it’s a tax expenditure subsidy as it would be subjected if it were an explicit “spending” subsidy, you want “the tax expenditure folks” to stop pointing out #1 and stop advocating for #2 except in the relatively small portion of tax expenditure subsidies represented by refundable tax credits? Really sounds like throwing out the [tax and fiscal policy improvement] baby with the [small potential gray area] bathwater.

  35. comment number 35 by: AMTbuff

    Brooks, I agree with your (2) above.

    I’ve been reading the latest report at http://www.taxpolicycenter.org/UploadedPDF/1001234_tax_expenditures.pdf

    and I have two important observations to add to my earlier comments:

    1. Another problem with calling tax breaks “tax expenditures” is the implicit assumption that the activity would not change if the tax break were removed, and that the revenue foregone can be computed by a simple multiplication, with no consideration for behavior change when the incentive is removed. In tax jargon, the analysis is static, which is clearly incorrect, sometimes wildly so. Certain activities would almost totally cease in the absence of a tax break. For further support of this point, see http://www.house.gov/jec/fiscal/tax/expend.pdf

    The final problem with the concept of “tax expenditure” is that it obscures the fact that the government has in effect made promises to taxpayers. Engage in that activity and you get this tax break. Government has the power to renege on its deals, but it would be dishonest to do so without several years of advance notice and/or grandfathering past decisions by taxpayers.

    Tax reform advocates of all stripes give distressingly short shrift to the need for government to play fair with taxpayers. The tax code provides incentives, taxpayers respond, then Congress feigns surprise and pulls the rug out from under us. Government demands honesty from taxpayers but not from itself. The language of tax expenditures implicitly encourages tax policy changes that will unfairly penalize taxpayers who made long-term decisions based on longstanding tax rules.

    In summary, there’s a lot more here than math. A whole lot more.

    Back to your item (1) above. One of the largest items is unfairly classified as a tax expenditure. I believe that income from defined contribution retirement plans cannot fairly be included in current year income unless the same treatment is somehow applied to employees (primarily government employees) with defined benefit plans. The present value of their benefits grows by tens of thousands of dollars per year as they approach retirement, just as does the value of an IRA or other defined contribution plan. You can’t ignore the former and yet call the latter a tax expenditure, but that’s exactly what all the current analyses do.

    Furthermore, the pension income tax break is only a timing break: all income is taxed when it is distributed to the recipient. Claiming to capture large revenue from imposing immediate taxation would be dishonest, because revenue will be lost later on when retirees receive after-tax payouts rather than pre-tax money.

  36. comment number 36 by: Brooks

    Re: 1. Another problem with calling tax breaks “tax expenditures” is the implicit assumption that the activity would not change if the tax break were removed, and that the revenue foregone can be computed by a simple multiplication, with no consideration for behavior change when the incentive is removed.

    I don’t think any sensible person makes that assumption regarding subsidies, whether those subsidies are in the form of tax expenditures or explicit “spending”. To the contrary, the general assumption is that you get more of things you subsidize (because you have essentially lowered the price to the consumer/purchaser). At least much of (and perhaps most/all) CBO scoring is bound by static analysis (because of the subjectivity involved with setting assumptions for dynamic analysis, but everyone (with a clue) realizes that there will be a behavioral response and thus effects (on GDP; revenue feedback; etc.) outside of static analysis.

    Re: The final problem with the concept of “tax expenditure” is that it obscures the fact that the government has in effect made promises to taxpayers. Engage in that activity and you get this tax break. Government has the power to renege on its deals, but it would be dishonest to do so without several years of advance notice and/or grandfathering past decisions by taxpayers.

    Again, all of the above would apply equally to the equivalent subsidies if they were in the form of explicit “spending” subsidies rather than tax expenditure subsidies (other than any timing differences and administrative differences) – e.g., if, rather than mortgage interest deductibility, the government sent people vouchers each month to apply toward their mortgage payment, or if it sent out a reimbursement check after the fact, right around tax time, either of which would be called “spending”. But if your point is that government should give a good amount of advance notice before reducing/eliminating subsidies, I suppose the optimal length of advance notice would have to be determined on a case by case basis, considering the typical planning time horizon for related purchases/decisions vs. the drawbacks of continuing the subsidy longer. Partial or even total grandfathering may be appropriate in some cases based on consideration of the same trade-off. In some cases a homeowner who bought assuming his mortgage payments would continue to be subsidized by other taxpayers (who pay more in taxes so that that incremental amount can be transferred to him) may be screwed if that subsidy were taken away.

    Re: Tax reform advocates of all stripes give distressingly short shrift to the need for government to play fair with taxpayers. The tax code provides incentives, taxpayers respond, then Congress feigns surprise and pulls the rug out from under us. Government demands honesty from taxpayers but not from itself. The language of tax expenditures implicitly encourages tax policy changes that will unfairly penalize taxpayers who made long-term decisions based on longstanding tax rules.

    At risk of being annoyingly repetitious, I’d first point out again that all you say above you should apply equally to subsidies that are in the explicit “spending” form, and many on the right will say what you’ve said would be the first people to shout for ending “spending” subsidies even though they are substantively no different from the same subsidies if provided in tax expenditure form. I suspect many people who decry, for example, the government sending out vouchers or reimbursement checks for people to apply to the purchase of some category of product (i.e., an explicit “spending” subsidy), calling it unjustified/wasteful spending, would not object as strongly to – and probably would even applaud – the same exact subsidy if it took the form of a tax deduction (tax expenditure). Would there be a serious fairness (and credibility) problem if the government promised reimbursement for such a purchase and then reneged? Sure. But again, the potential unfairness of such changes has to be weighed, on a case by case basis, against the drawbacks of continuing the subsidy at the expense of other taxpayers.

    Re: your discussion of the treatment of income from defined contribution retirement plans, I’m unfamiliar with it, but I think my point in my prior comment applies – no on is saying we should decide all or none on tax expenditures (they should be considered on a case by case basis and their merits judged) so the semantics shouldn’t be all that important. Do we want taxpayers to pay more in taxes to subsidize others’ employer-provided health insurance? to subsidize others’ decision to buy a home? to subsidize others’ decision to have a child or another child? etc. And should such subsidies be treated passively in our budget process as entitlements or subject to the greater/more frequent scrutiny of discretionary spending? And by the way, should the size of the subsidy — the additional amount that other taxpayers must pay to provide others with the subsidy — increase according to the subsidized person’s income? These are all questions to ask on a case by case basis, along with all the sub-questions pertaining to benefits and drawbacks, of course.

  37. comment number 37 by: Brooks

    AMT,

    By the way (and this may not relate to your point; I’m just using it to offer an example), when someone is allowed to contribute to his IRA with pre-tax dollars and have it tax deferred, I’d view that as a subsidy — a subsidy to encourage saving because of presumed positive externalities (plus perhaps a bit of “it’s good for you” governmental paternalism) — and it’s akin to the equivalent of other taxpayers doing what some employers do with matching of an employee’s contribution. It would be the same as if it weren’t tax deferred, the person paid taxes on that income now, and the present value of what would have been the tax savings from deferral sent to him as a government subsidy check, as a reward (and incentive) for saving. Again, it’s kind of like employer matching, except it’s other taxpayers who are paying more in taxes in order to provide this reward/incentive to that person. Is the subsidy good policy? Maybe. Maybe not. But it wouldn’t be any more attractive/unattractive if it were provided as an explicit “spending” subsidy (assuming the amounts could be calculated correctly) in terms of substance (i.e., leaving aside the politics that arise from misconceptions re: tax deduction subsidies and “spending” subsidies). And it doesn’t really matter if we call it a tax expenditure or not; it’s a subsidy with benefits (positive externalities) and costs, and the merits of it can be debated.