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Tax breaks and loopholes that cost us $1 trillion a year have staunch defenders

By Edmund L. Andrews and Lori Montgomery
Sunday, May 2, 2010; G01

Montgomery is a Post staff writer. Andrews works for the Fiscal Times, an independent digital news organization that specializes in fiscal and economic matters. It is funded by Peter G. Peterson, who separately supports groups that advocate for long-term debt reduction.

Under the new health-care law, millions of Americans will get government help to cover medical bills. Many will simply be added to the rolls of Medicaid, the government health plan for the poor. But the rest will get their subsidies a different way -- through tax credits that lower the cost of their insurance premiums and co-payments.

The new tax credits, which will eventually cost the government more than $50 billion a year, are part of a growing array of federal benefits offered through the tax code. Known as "tax expenditures" in budget jargon, such tax breaks were worth more than $1 trillion to recipients last year.

That's more than the government spent on Social Security, and nearly enough to balance the federal budget.

And their cost is growing. Even if Congress doesn't add any tax credits, analysts predict that the rising cost of existing tax breaks could add about $3 trillion dollars to the federal debt by 2020. With policymakers looking for ways to reduce soaring deficits, lawmakers in both parties are taking a fresh look at paring them back, perhaps as part of a broader tax-reform effort.

"Our tax system is inefficient and riddled with special exceptions," said Alice Rivlin, a scholar at the Brookings Institution and a member of President Obama's bipartisan deficit commission, which held its first meeting last month. "If you are looking for additional revenue over time, one approach is to move in the direction of reforming the income tax."

Congress last cleaned up the tax code in 1986. Since then, special breaks have proliferated with bipartisan support and now permeate almost every corner of American life. The tax-free treatment of employer-paid health insurance will cost the government $160 billion this year, according to the Treasury Department. The tax break for mortgage interest will cost $92 billion. And deductions for state and local taxes will take $34 billion from federal coffers.

Republicans see tax breaks as a way to spur business investment and rein in the growth of government. Democrats use them to channel money toward social programs -- low-income housing, assistance for low-income workers, college tuition and green energy. But analysts say many of the biggest tax breaks have a built-in tendency toward cost escalation, similar to the automatic, formula-driven growth of old-age entitlement programs.

"Budget wonks rail about limiting entitlement programs like Medicare and Social Security, but a large and growing share of federal spending is off the radar screen," said Leonard E. Burman, a tax policy expert at Syracuse University. "Tax expenditures are on autopilot."

Indomitable breaks

The automatic escalation stems from a host of causes. Rising medical costs drive up the cost of tax breaks for health insurance, for example. And rising personal incomes nudge more people into higher tax brackets, which increases the value of their deductions.

But paring back or eliminating a tax break is no easier than eliminating a spending program. Even obscure loopholes have armies of defenders, and giant tax breaks such as the ones for mortgage interest and employer-paid health insurance are considered all but untouchable.

The Obama administration learned that lesson during the battle over health care. Democrats initially proposed limiting the tax-free treatment of employer-provided coverage through a new tax on expensive "Cadillac" insurance policies. But labor unions objected, and lawmakers scaled back the tax and postponed its implementation until 2018.

Critics say such tax breaks often provide bigger subsidies to people with higher incomes. The tax deduction for mortgage interest, for example, offers bigger benefits to people with more expensive houses. Almost two-thirds of all Americans, most on the middle and the lower rungs of the income ladder, cannot even take a deduction for mortgage interest because they don't itemize their taxes.

Cleaning up the code

As a political matter, lawmakers say it is difficult to raise much money by attacking individual tax breaks because even the most obscure loopholes have active defenders.

"Unless you put it in the larger context of tax reform, you're most likely not going to succeed," said Paul Weinstein, a fellow at the Democratic Leadership Council, a Democratic think tank. "You need to offer something in exchange, like simplification and lower rates."

White House officials are looking at ways to clean up the tax code. In his budget proposal for next year, Obama proposed narrowing a number of breaks to save a total of $750 billion over 10 years. The President's Economic Recovery Advisory Board, headed by former Federal Reserve chairman Paul Volcker, is supposed to produce a list of proposals for simplifying the tax code in about a month.

Meanwhile, Sen. Judd Gregg, (R-N.H.), who sits on the president's fiscal commission, has co-sponsored a bill with Sen. Ron Wyden (D-Ore.) that would eliminate dozens of special breaks and use the money to keep overall tax rates low. The Wyden-Gregg proposal would reduce the number of tax brackets to three -- 15 percent, 25 percent and 35 percent -- and reduce the corporate tax to 24 percent from 35 percent.

"Why should the sole focus of Congress be on pouring more money into a broken system?" Wyden said. "There have been thousands of tax breaks added in the last several years. Wouldn't it make sense to drain the swamp?"

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