“Just do it!”
Those encouraging words, once used to advertise athletic shoes, could apply equally well to efforts to reform America’s convoluted tax code that runs to nearly 72,000 pages. With tax day behind us for another year, it’s worth exploring whether our tax regime could be simplified and rates lowered in the process. After all, it’s been done before. I served on the House Ways and Means Committee in 1986 when Democrats and Republicans in Congress worked with President Ronald Reagan to streamline the tax code, lower rates and make the process of paying taxes much less onerous than it had been before. But that was then and this is now. Can the process be repeated?
U.S. Sen. Max Baucus, D-Mont., retiring chairman of the Senate Finance Committee, recently launched an ambitious plan to do just that. During his committee’s first meeting on the topic, Baucus even gave each senator small packages of M&M candies with pictures of previous tax reformers on the packages. (Thank you, Mars Inc.) I applaud Baucus and wish him every success. But he faces a daunting task of identifying which tax breaks to cut or eliminate, a process that will pit him and his committee against an army of vested interests.
By vested interests, I surely mean oil and gas companies, coddled millionaires and other favored groups that have cozy relations with Congress, right? Well, here’s where we need to look in the mirror to recognize how difficult it will be to rein in the enormous tax “expenditures” putting big holes in our revenue stream. The middle class is by far the biggest beneficiary of these tax breaks, and everyone from labor unions to homeowners to parents will cry out against changes that reduce their benefits and increase their tax burden.
Let’s take a closer look. Based on estimates from Congress’ Joint Committee on Taxation, the Committee for a Responsible Federal Budget (crfb.org) reports that the most costly tax breaks for the period 2013-2017 are: Employer-Provided Health Insurance Exclusion ($760 billion); Preferential Tax Rates on Dividends and Capital Gains ($616 billion); Mortgage Interest Deduction ($379 billion); Earned Income Tax Credit ($326 billion); Child Tax Credit ($292 billion); State and Local Tax Deduction ($278 billion); Deferral of Corporate Foreign-Source Income ($266 billion); Step-up Basis for Capital Gains at Death ($258 billion); and Charitable Deduction ($183 billion).
Taken together, these tax expenditures account for nearly half the total cost. Only one corporate tax break ranks near the top, and it’s dwarfed by tax breaks for individuals – yes, including some wealthy individuals. The single largest is the tax break for employer-provided health insurance premiums, a benefit which also contributes to higher health care costs. Special tax breaks for oil and gas companies and other industries amount to a small share of the total.
Tax expenditures act just like direct spending programs that give entitlements to favored classes, and they put just as big a hole in our budget. They will cost roughly $1.3 trillion in 2013, or about the same amount Congress has allocated for all discretionary spending and more than the money expected to flow into federal coffers from individual income taxes ($1.2 trillion).
Tax expenditures have grown much faster than direct spending in recent years. Why? Legislators know constituents want them to hold the line on spending. Tax expenditures offer a less visible but equally effective way for legislators to hand out benefits without seeming to break the budget. But these tax breaks, no matter how worthy or popular, contribute just as much to our deficits as the spending Congress votes on each year.
So how can we rein in tax breaks that benefit so many middle class households, along with a wide range of other interested parties? It won’t be easy. But despite the difficulties, tax reform would be worth the effort. A streamlined and reformed tax code would make paying taxes easier and cheaper for millions of individuals and companies, allow lower rates, improve our investment climate and equalize tax burdens. While many households gain from tax breaks, the top 20 percent of earners garner the largest share of benefits.
Ideally, in my view, tax reform also would be used to raise revenue and stanch the bleeding in our federal budget deficits. Capping total deductions is one option; many other ideas have been proposed. The question is, are we as a nation prepared to pay for the services and benefits we receive from government? Baucus and his Finance Committee colleagues are about to find out.
Joanna Shelton was deputy secretary general of the Organization for Economic Cooperation and Development in Paris and held senior positions in the executive branch and Congress in Washington, D.C. She has taught undergraduates and adults at the University of Montana. Her column appears the first Sunday of each month.