Economist's View: "The 'Tax Expenditure' Solution for Our National Debt"

Economist View:

The economy is still fragile, and now is not the time to begin solving our long-run debt problem. That would make things worse. But once the economy is on firmer footing, we will need to begin addressing this problem. Martin Feldstein argues that the elimination of special tax rules is a good way to reduce the long-run debt load:

The 'Tax Expenditure' Solution for Our National Debt, by Martin Feldstein, Commentary, WSJ: When it comes to spending cuts, Congress is looking in the wrong place. Most federal nondefense spending, other than Social Security and Medicare, is now done through special tax rules rather than by direct cash outlays. ...

These tax rules—because they result in the loss of revenue that would otherwise be collected by the government—are equivalent to direct government expenditures. That's why tax and budget experts refer to them as "tax expenditures." This year tax expenditures will raise the federal deficit by about $1 trillion... If Congress is serious about cutting government spending, it has to go after many of them. ...

Neither party has focused on controlling this kind of spending. Democrats are reluctant to cut such programs... Republicans also are reluctant to cut these tax perks, because they regard the additional revenue collected by the federal government as a "tax increase"—even though the increased revenue is really the effect of a de facto spending cut. ...

But eliminating tax expenditures does not increase marginal tax rates or reduce the reward for saving, investment or risk-taking. It would also increase overall economic efficiency by removing incentives that distort private spending decisions. And eliminating or consolidating the large number of overlapping tax-based subsidies would also greatly simplify tax filing. ...

If tax expenditures are not cut, taxes on households and businesses will have to rise to prevent an explosion of the national debt... When benefits for Social Security and Medicare are set aside, the rest of the outlay side of the budget is too small—7.5% of GDP—to provide much scope for reducing annual budget deficits that are now projected to average 5% of GDP for the rest of this decade. In contrast, total tax expenditures are now 6.4% of GDP.

Not every type of tax expenditure should be cut. Some provide good incentives while others increase the fairness of the tax system. But they can be reduced by one-third or more. ... Cutting them ... 2% of GDP would reduce the national debt in 2020 by some $4 trillion, bringing the projected debt down to 72% of GDP from 90%. ...

Cutting tax expenditures is really the best way to reduce government spending. And to be politically acceptable, the cuts in tax expenditures must be widespread... While some of the dozens of small tax perks should be eliminated all at once, others should be reduced gradually in order to avoid economic disruptions. Some of the biggest ones, like the deduction on federal tax returns for local property taxes (projected to cost the federal government $25 billion in the coming fiscal year) might be reduced but not completely eliminated. ...

The American public wants to reduce ... deficits... A major reduction of the spending that is built into our tax code is the best way to achieve that.

There aren't any easy solutions to the long-run debt problem. There are special interests attached to each of these tax breaks, so it won't be easy to eliminate enough of them to make a difference. A bill eliminating a substantial number of breaks could be portrayed as a vote against all sorts of popular and/or powerful groups and scare legislators away from supporting such legislation. I know my first thought was that care would need to be taken to ensure that we don't eliminate provisions that help to attain equity or that promote other worthy societal goals, and every group facing the elimination of their tax break will argue that it is needed for these reasons. But these arguments will be made no matter what we do, and to the extent that we can eliminate these tax provisions without harming our ability to pursue these goals, we ought to do so.

However, with that said I should also note that the main driving force behind the long run debt problem is health care costs -- if we solve the health care cost problem then we also solve the debt problem, and if we don't, we don't. Since eliminating these "tax expenditures" does not help with the health care cost problem at all, there's no reason compromise our ability to promote equity or other goals by being overly aggressive in eliminating these tax breaks. Not all of these tax provisions serve a worthy purpose, but many do and those should be preserved.

Posted via email from Jim Nichols