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Even Mitch McConnell Is Starting to Ponder the Spending That’s Done Through the Tax Code

May 25th, 2011 . by economistmom

(Video courtesy of Huffington Post.)
As David Callahan writes on Huffington Post (emphasis added):

Such steps [to broaden the tax base by reducing tax preferences, or "tax expenditures"] would command support from an unusual cast of characters. Many fiscal conservatives dislike offering a plethora of deductions in the tax code because it uses the tax system for “social engineering” and — in regard to corporate taxes — puts the government in the business of picking winners and losers. Meanwhile, progressives don’t care for key individual tax breaks because they mainly benefit high earners. Also, of course, progressives hate the billions in tax breaks given to oil companies and other corporations.

All in all, it is possible to imagine a bipartisan deficit reduction deal in which large new revenues are raised by closing loopholes. That is clearly where some members of the Gang of Six (now five) have been for weeks. Last month, Republican Senator Tom Coburn [the departing gang member] said on Meet the Press that he would favor a “net” increase in revenue if it didn’t raise tax rates.

It is even easier to imagine that scenario after a television appearance yesterday by Senate Minority Leader Mitch McConnell, who said that Republicans were dead set against higher tax rates. As reported by CNN.com: “Chris Wallace of Fox caught the distinction and asked McConnell if his language indicated he was open to collecting more tax revenue by ending some subsidies and loopholes. McConnell deflected the question, saying he wouldn’t negotiate a deal on the program.”

Maybe I’m naive, but that sounds like a clear signal that at least Senate Republicans would go along with a tax reform plan that raises revenue.

And incidentally, the Tax Policy Center’s Donald Marron has an excellent column on this very issue in this week’s print edition of the Christian Science Monitor–available online here–where he explains:

Here’s a shocker: America can cut government spending by eliminating tax breaks.

I know that sounds crazy. Everyone usually talks as if spending and tax breaks are distinct. Spending is what the government gives out or uses for purchases; tax breaks reduce how much revenue it collects.

Reality, however, is a lot blurrier. Hundreds of billions of dollars of spending are disguised as tax cuts.

It’s not hard to see why. Voters like tax cuts more than spending increases. Politicians understand that, so they convert spending into tax breaks.

I truly believe that, at least eventually, more policymakers from both sides of the aisle and both houses of Congress–and even the guy down on the other end of Pennsylvania Avenue–will discover that reducing tax expenditures are their favorite way, not just to reform the tax system, but to reduce the deficit.  In other words, they will have to come around to the idea of reforming the tax system, not just to make the system more efficient and/or fair in raising any old amount of revenue (usually “constant” is the preferred tax reform goal), but the most efficient and/or fair way to raise a higher amount of revenue and reduce the deficit.  Not that this will be a pleasant thing to do, especially when politics are involved, but I really doubt the politicians can find a surer, more efficient, and fairer way to (actually and substantially!) reduce the deficit with any other type of spending cuts.

Eventually almost everyone–or at least a majority–will come around to the fact that although we’d rather avoid tax (revenue) increases and keep believing in painless solutions (which don’t really exist), deficit reduction that’s achieved through base-broadening tax reform that reduces “tax entitlements” sure seems quick and easy compared with the alternative of cutting the other big entitlement programs–namely, Medicare/Medicaid and Social Security.  (In the video clip above, McConnell clearly distances himself from the Medicare/Medicaid cuts as spelled out, more than elsewhere at least, in Paul Ryan’s plan.) Don’t get me wrong:  At least some degree of those other tough choices over the other big entitlements will have to be made, too, but those are changes that will materialize only over the much longer term and with a much greater degree of uncertainty, and frankly, we don’t have a lot of time and money to spare.  It sure would be good to actually “get somewhere” with deficit reduction over the next five to ten years.

21 Responses to “Even Mitch McConnell Is Starting to Ponder the Spending That’s Done Through the Tax Code”

  1. comment number 1 by: Mike Moxcey

    I’m not going to hold my breath. Americans have a bizarre belief in the primacy of voting–that a plurality trumps logic or economics or science or common sense.

    As long as the Tea Partiers think they have a mandate to repeal the rules of arithmetic, I mean erase the debt merely thru spending cuts, then nothing useful will happen.

  2. comment number 2 by: WillHarper

    It’s either increase revenues through tax code reform including doing away with loopholes and deductions, or third world status for the US within the next 50 years. Declining revenue has been on a collision course with govt spending for many years.

  3. comment number 3 by: SteveinCH

    Declining revenue?

    Would you like to give us some facts to support that contention?

    Here’s two looks at revenue (1945 to 2008) that would seem to contradict your contention.

    Here we have revenue in inflation adjusted dollars

    http://usgovernmentrevenue.com/downchart_gr.php?year=1945_2008&view=1&expand=&units=k&log=linear&fy=fy12&chart=F0-fed&bar=1&stack=1&size=m&title=&state=US&color=c&local=s

    And here it is as a percentage of GDP

    http://usgovernmentrevenue.com/downchart_gr.php?year=1945_2008&view=1&expand=&units=p&log=linear&fy=fy12&chart=F0-fed&bar=1&stack=1&size=m&title=&state=US&color=c&local=s

    The only issue with revenue is it hasn’t been growing as fast as spending.

  4. comment number 4 by: AMTbuff

    base-broadening tax reform that reduces “tax entitlements” sure seems quick and easy compared with the alternative of cutting the other big entitlement programs–namely, Medicare/Medicaid and Social Security

    Exactly. Conservatives are resisting this dilatory approach of increasing revenue rather than rationalizing those spending programs which grow much faster than the economy.

    Once the spending beast has been truly and securely chained, conservatives will be very willing to feed it adequately. Tax reform is the leading candidate for that task. Spending that money before making the necessary structural changes would be most unwise.

    That’s why ObamaCare was such a huge mistake: It was like remodeling the kitchen when that money was urgently needed for structural repairs to prevent collapse of the entire house. Enjoy that kitchen while you can.

  5. comment number 5 by: Gipper

    AMTbuff,

    Perfect analogy with the kitchen remodeling. This loss by the Republicans in the NY special election will only stiffen Republicans’ resolve to force Democrats to come up with spending cuts.

    No way will this debt limit be increased without Democrats spilling some blood. Republicans can’t shoulder the entire political burden.

  6. comment number 6 by: Brooks

    If I can speak more broadly to the general topic of the video, it’s just awful that Republicans are in the vulnerable position in which they find themselves due not primarily to the Ryan budget in itself, but rather due to the combination of the Ryan budget and Obama’s (and Congressional Democrats’) decision to use it as an opportunity to play politics rather than to respond in kind with an equally fiscally-responsible budget (or other form of plan) that would achieve a similar degree of mitigation of our mid/long-term fiscal imbalance. Obama set that strategy in place with that speech last month — laying out (in the speech and related document) something far inferior in terms of both degree of imbalance-mitigation and details/specifics.

    He/they could have chosen instead to respond to Ryan’s initiative by responding in kind, thus establishing a positive tit-for-tat that would have encouraged further political courage and fiscal responsibility, and established a debate on a level playing field (equal imbalance-mitigation) over which sacrifices we want to make.

    Instead Obama and the Democrats chose to go for short-term political gain, in the process not only greatly reducing the chances of immediate major progress, but also teaching all in Washington a lesson that will linger — that if one party sticks its neck out with some plan for fiscal responsibility, the other party will likely do its best to chop that head off rather than use it as a chance to achieve fiscal responsibility and have a fair fight over the extent to which each party/ideological side should get what it wants as the means to achieve it.

    That’s why I was disappointed with Diane’s rating of Obama’s speech as “Not Perfect, But Good” http://economistmom.com/2011/04/not-perfect-but-good/#comment-34396

  7. comment number 7 by: Russ

    actually, we do NOT agree. It is always maddening to read that that tax break reduce revenue when the exact OPPOSITE is true. EVERY TIME taxes are reduces, revenue shoots up. This is even true after the reviled (by liberals) Bush tax cuts. From 2003-2007, we saw huge increases in revenue. Yes, we still outspent it. My source is the actual US Treasury. It’s not hard. Look it up yourself. Thank god those cuts were there or our deficit would be much worse than it is now. Simplistic people, like the author of this story, only see “lower taxes, lower revenue”. They always, ALWAYS, fail to understand economics 101. Cause and effect. The government has more than one source of revenue. It makes it up in a myriad of other revenue streams from increased economic activity and investments. Do your research before writing this tripe.

  8. comment number 8 by: AMTbuff

    Russ, no serious economist, right or left, believes that tax revenues will always be higher at lower rates. Laffer himself would not say that. I have seen no credible study claiming that current rates are on the high side of the Laffer peak. Get back to me when rates are at 70% and I might agree with you.

    You can make the argument that tax increases have high deadweight loss without going overboard and claiming that they don’t even raise revenue.

  9. comment number 9 by: Brooks

    Russ,

    AMT is correct. I’ll provide some support for his claim re: what economists say, and I’ll explain the analytical errors you are making (I don’t know if you’ll listen, but if you do, you’ll learn something and perhaps you won’t again passionately heap criticism on someone on the basis of your invalid approach and belief).

    First, you are mixing together tax credits/deductions and tax rate cuts, as if we can presume they have a similar impact, even though the incentives they each provide are quite different. My guess is that you are really thinking of tax rate cuts.

    Second, the proper analytical question is not “Did revenues grow following a tax rate cut?” but rather “Were revenues higher than they would have been without that tax cut?” Obviously this involves a counter-factual, but that’s why the guys with the PhDs in economics try to sort it out empirically (via data analysis, attempting to control for other variables) and applying theory to some extent.

    Third, you erroneously assert that those who disagree with you “fail to understand economics 101″. Well, you and other conservatives who perpetually repeat the talking point re: revenues rising after some tax or after the last couple/few tax cuts fail to understand correlation analysis 101 (and that’s even leaving aside the next step of establishing causation). You can’t just look at higher revenues following even several tax rate cuts and conclude a strong correlation between higher revenues and tax rate cuts unless you ask what has happened to revenues in the absence of tax rate cuts (either no tax rate cut or a tax rate increase). If that had occurred to you, you would realize that it’s possible that revenues have a general upward trend over time regardless of whether tax rates go up, down, or neither. That isn’t to say that such changes don’t impact revenue levels; It’s that the economy is more often expanding than in recession, and that growth often/generally has greater impact on revenues than do tax rate changes, particularly over a few years. So if one applied your invalid approach, one could probably claim a strong correlation between tax increases and higher revenues, or between no tax rate changes and higher revenues.

    Lastly, the support. A few years ago I compiled a list of quotes of the most prominent conservative economists (and some more neutral) I could find opining on this question (and this was pre-financial crisis and pre-recession, at a time more favorable to the Bush tax cuts in terms of revenue levels). They all expressed the view that income tax rate cuts from anywhere near the levels prior to the Bush tax cuts are highly unlikely to generate higher revenues vs. what revenues would have been without the tax rate cuts. There is some degree of incremental economic growth, and therefore some “revenue feedback effect”, meaning the likely loss in revenue won’t be as great as one would calculate if he failed to adjust for incremental growth, but that revenue feedback effect is highly unlikely to be great enough to offset the effect of the lower rates, meaning it is highly unlikely there would be a net gain in revenue. See my compilation at http://swordscrossed.org/node/1671

  10. comment number 10 by: B Davis

    Brooks wrote:

    A few years ago I compiled a list of quotes of the most prominent conservative economists (and some more neutral) I could find opining on this question (and this was pre-financial crisis and pre-recession, at a time more favorable to the Bush tax cuts in terms of revenue levels). They all expressed the view that income tax rate cuts from anywhere near the levels prior to the Bush tax cuts are highly unlikely to generate higher revenues vs. what revenues would have been without the tax rate cuts.

    That’s a very good compilation. I’ve likewise noticed that all credible economists and economic studies seem to agree that income tax cuts are not a free lunch. They may have benefits but higher revenue is not one of them. I had thought of compiling them all into a list but never did so. I did post some of interesting statements and studies that I had run across at this link. I also posted an independent analysis of the Reagan, Kennedy, and Bush tax cuts at this link. Anyhow, thanks for posting your compilation. It would be interesting to see if any supply-sider has attempted to post a list of prominent economists and/or economist studies that support the notion that tax cuts increase revenue. I suspect not since I believe that such a list would be VERY short!

  11. comment number 11 by: Brooks

    B Davis,

    Thanks. And thanks for the links to your info & analysis.

  12. comment number 12 by: Brooks

    B Davis,

    Your posts reminded me that a few years ago I posted this illustration showing The Logic of the Laffer Curve http://swordscrossed.org/node/1672 (As noted there, I assume a flat tax for simplicity of the illustration)

  13. comment number 13 by: B Davis

    Brooks,

    Thanks for the link on the Laffer Curve. That reminds me of an IMF Paper that a reader of my blog suggested I look at and on which I commented on in the last comment at this link. I found it interesting in that it suggested that the effect of a tax cut or increase on compliance is greatly affected by the strength of a country’s “tax authority”. To quote the study:

    If tax authorities are relatively strong (at least relative to the prescribed taxes), then compliance is the best strategy for the overwhelming majority of taxpayers. Tax rate cuts or increases do not change compliance much, as audits ensure it. Similarly, if the tax authority is relatively weak, no tax rate changes will induce compliance. With medium level tax authority strength, however, tax rates can have a pivotal role.

    As described in the paper, I believe that tax authorities are relatively strong relative to taxes in the United States. If this is the case, then the paper suggests that tax rate cuts would “not change compliance much, as audits ensure it”. Tax rate cuts would only be expected to have such an effect in countries with weaker tax authorities (like Russia) or countries with a higher tax rate.

    This is further evidence that the Laffer Curve is overly simplistic in asserting that the tax rate is the only major factor affecting revenue. The strength of a country’s “tax authority” may also play a crucial role.

  14. comment number 14 by: Brooks

    B Davis,

    “Tax avoidance” refers not only to failure to comply (to pay in taxes what one owes by law), but also to financial maneuvers a taxpayer can take to legally reduce his tax liability. At higher tax rates, presumably more of that will occur.

  15. comment number 15 by: Arne

    I’m surprised to see Brooks mix up tax evasion with tax avoidance. Failure to comply is tax evasion.

  16. comment number 16 by: Brooks

    Arne,

    I said that “tax avoidance” includes both failure to comply (i.e., tax evasion) and financial maneuvers a taxpayer can take to legally reduce his tax liability. Now, what are you saying I got wrong? Are you saying that tax evasion is not one component of “tax avoidance”?

  17. comment number 17 by: Brooks

    Apparently, I was wrong http://www.investopedia.com/terms/t/tax_avoidance.asp

    Tax evasion is apparently distinct from tax avoidance, and the latter is only legal means of reducing one’s tax liability.

    So, while I should indeed have pointed out to B Davis that I was not referring only to tax evasion (which he seemed to be equating with “tax avoidance”), I should not have said that “tax avoidance” covers both. And my Laffer Curve illustration should refer to tax avoidance and tax evasion, not just to tax avoidance.

  18. comment number 18 by: AMTbuff

    One step down from tax avoidance is reduction of gross income by working fewer hours, retiring early, or most commonly by refraining from selling appreciated assets. None of these techniques is considered tax avoidance, but they all reduce reported taxable income from what it could have been at lower tax rates.

  19. comment number 19 by: Arne

    A “high powered” tax attorney can make what any reasonable person would see as tax evasion appear to be tax avoidance. His job is made much easier if no one is checking his work - if the tax authority is weak.

  20. comment number 20 by: B Davis

    So, while I should indeed have pointed out to B Davis that I was not referring only to tax evasion (which he seemed to be equating with “tax avoidance”), I should not have said that “tax avoidance” covers both. And my Laffer Curve illustration should refer to tax avoidance and tax evasion, not just to tax avoidance.

    Brooks,

    Actually, I have no disagreement with your Laffer Curve illustration and I see that it does mention avoidance and evasion. That’s why I thanked you for posting the link. When I followed with “That reminds me…” and spoke of the simplicity of the Laffer Curve, I was speaking of the usual one that shows revenue to be a function of only tax rates, like the one at this link. The IMF paper suggests that the strength of a country’s “tax authority” may also be a crucial factor. It’s the suggestion that the tax rate is the one and only factor that is overly simplistic, not your illustration.

  21. comment number 21 by: Brooks

    B Davis — I added the “tax evasion” part yesterday after finding out that “tax avoidance” didn’t cover both legal means and tax evasion, but only the former. In any case, if I misrepresented your thinking, sorry.

    AMT — re: “working fewer hours”, etc., I think my Laffer Curve illustration (at the link) covers that under reduced incentives to work and invest (along with tax avoidance for timing of realizing cap gains).