Let's freeze more than chump change
President Obama has proposed to freeze most domestic discretionary spending -- a step in the right direction, but not enough. The $250 billion in expected savings over the next decade is chump change compared with deficits that could top $10 trillion if policy doesn't change.
As the president has stressed, those deficits are an enormous threat to our prosperity. So how could he make a real dent in the deficit? We should subject tax expenditures to budget discipline.
"Tax expenditure" is the technical name for spending programs run through the tax system -- all of those tax breaks that politicians of both parties love to dole out like Christmas presents. The mortgage interest tax deduction and the exclusion for employer-sponsored health insurance are among the most well-known such items.
At the same time the president promised restraint on a sliver of the federal budget, he proposed new tax breaks for child care, retirement savings and small-business capital gains. This is a perverse kind of gift: Many of the goodies the political Santas leave under our trees will be paid for, with interest, by our kids.
But suppose Obama's "freeze" were also applied to tax expenditures. Say we postponed its effect until fiscal 2013 so that the effects do not threaten a nascent economic recovery. Capping tax expenditures at 2012 levels for three years and indexing the cap for inflation after that, as proposed for non-security discretionary spending, would reduce the deficit by about $3.5 trillion. That's right -- 14 times as much as what the president's spending freeze would save.
A cap on tax expenditures would raise so much money because the expenditures are big and growing fast. The Office of Management and Budget counts 180 of them, totaling more than $1.1 trillion.
No, capping tax expenditures would not be easy. Almost all are on autopilot: Like Social Security and Medicare, they will grow forever if Congress does nothing. Congress would have to subject the hidden welfare state to annual review. To meet the constraints and reduce costs, some tax expenditures would have to be eliminated or redesigned. This would be a good thing. Like direct spending, some tax expenditures are inefficient and poorly targeted and thus not worth paying for.
Yet the political challenges to controlling tax expenditures are daunting. Conservatives would criticize cuts in tax expenditures as tax increases and complain that they violate the president's campaign promise to never raise taxes on middle-class families. Liberals would worry about threats to their favorite subsidies.
Nonetheless, there are good reasons for conservatives and liberals to support limits on tax expenditures.
Tax expenditures have proliferated in large part because they enable politicians to promote their pet causes while appearing to lower taxes. But tax expenditures require higher tax rates to cover their cost, just like direct expenditures, and they impose higher burdens on those who don't share in the benefits. A study published in 2008 found that eliminating all individual income tax expenditures would permit a 44 percent across-the-board cut in tax rates without reducing revenue. The top marginal rate could drop from 35 percent to 20 percent. Conservatives could stand up and cheer.
Conservatives might also take note because tax expenditures are mischaracterized as tax reductions rather than spending, so the federal government appears to be much smaller than it really is. And the expenditures require the kind of top-down regulation from Washington that conservatives scorn.
Liberals should care because tax expenditures crowd out direct expenditures, even when the latter would work better or cost less. Most tax expenditures are worth more to high-income than to low-income households. (High-income families benefit more because they face higher rates and are more likely to owe tax.) For example, would it make sense to design a health insurance voucher worth 35 cents per dollar for high-income families, but only 10 cents per dollar for those with low incomes? No, but that is the way the tax subsidy for employer-provided health insurance works. Liberals would surely want more benefits going to those who need help.
A major cut in tax expenditures might seem like pie in the sky if it hadn't happened before. The Tax Reform Act of 1986 cut tax expenditures and tax rates. The bipartisan compromise that Ronald Reagan forged with Republican and Democratic leaders in Congress cut the top individual tax rate from 50 to 28 percent, with no sacrifice in tax revenue.
I'm not arguing to eliminate all tax expenditures. It makes sense to run some programs through the tax system instead of setting up another bureaucracy. I just think we ought to subject these expenditures to the same fiscal constraint and scrutiny that the president wants to apply to other domestic spending programs.
The $3.8 trillion budget the president proposed Monday comes with a $1.6 trillion deficit. If we don't rein in tax expenditures, we have little hope of ever taming the budget.
The writer, a professor of public administration and economics at the Maxwell School at Syracuse University, directed the Urban-Brookings Tax Policy Center from 2001 to 2008 and served as deputy assistant Treasury secretary for tax analysis from 1998 to 2000.