StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

The entitlements no one is talking about

03 Mar 2010
Posted by Edmund L. Andrews


     Here is an article I just published in The Fiscal Times, prompted in part by Leonard Burman's work,  on the staggering size and automatic growth of "tax expenditures" -- tax breaks, for us non-budget mavens.

     Everybody knows that tax breaks -- on everthing from mortgage interest to green-energy projects -- permeate American life and often amount to backdoor government spending.  Republicans love to promote tax cuts, because they seem to strike a blow against Big Government.    Democrats love them because many tax breaks are a way to fund favored social programs.

     What you may not know -- I confess that I didn't -- is that the cost of existing tax breaks rivals the costs of Medicare and Social Security and is growing every bit as fast as the two giant entitlement programs.  In fact, the automatic escalation of tax breaks is very similar to that of entitlement programs.

     Some factoids:

      *Aggregate revenue drain from tax breaks topped $1 trillion in 2009 and actually exceeded the total money collected from personal and corporate income taxes.  By contrast, Social Security outlays are expected to hit $730 billion this year and Medicare to hit $451 billion.

      *The cost of existing tax breaks is soaring three or four times as fast as inflation.  Even if Congress doesn't add a single new one, the automated escalation -- above and beyond inflation --  will cost the government $2.85 trillion between now and 2020.

      *The biggest single tax break, for company-paid health insurance, will drain about $160 billion in 2010 and about $248 billion in 2015.  Those estimates are straight from Treasury, by the way.

      Those are huge amounts of money, but they are almost completely off the public radar.  Public debates about long-term fiscal problems always focus  on the growth of Medicare and Social Security.  That's fine, but it ignores a huge part of the issue.

      Burman, somewhat facetiously, proposes that we simply freeze tax expenditures for three year and cap their growth after that at the rate of inflation.  For practical and political reasons, that isn't going to happen.

       What could be possible, though, is a top-to-bottom tax reform, ala 1986, that wipes out most tax breaks and lowers overall rates.   At  the  end of the  day, the total tax burden would have to go up.   But that's a discussion worth having.






Staggering information. Far

Staggering information. Far more important than anything that will Americans will actually read or see in the MSM tonight or tomorrow morning.

Excellent post, keep talking about it

What could be possible, though, is a top-to-bottom tax reform, ala 1986, that wipes out most tax breaks and lowers overall rates.

Something to be devoutly desired.

At the end of the day, the total tax burden would have to go up.

Tax burden would be reduced to the extent such a reform is deficit neutral ala 1986.

This is, again, because the deadweight cost of taxes rises by the square of the rise in the tax rate. Which can be a lot.

As Mankiw put it:
"if we double the size of a tax, the deadweight loss increases four-fold; if we triple the size of the tax, the deadweight loss increases nine-fold."

By arithmetic, increasing tax expenditures -- narrowing the tax base -- requires an increase of tax rates to collect the same amount of revenue, thus increasing the deadweight burden of taxes on the economy without increasing revenue. Which is a bad deal for everyone, except the special interest receiving the tax expenditure.

Doing the reverse, ala 1986 -- broadening the tax base to obtain the same amount of revenue while lowering tax rates -- reduces the deadweight cost of taxes on the economy. A good deal for everyone, except the special interest that loses the tax expenditure.

The tax burden may have to go up at the end of the day anyhow for other reasons, such as to pay for entitlements -- but if so we want to lower it as far as possible first, and keep it as low as possible.

Responding to Jim Glass


       You are right, of course, that the 1986 tax overhaul was revenue neutral and did not increase the overall tax burden.  Unfortunately, I don't think we have that luxury today, given the govt's newly-expanded debt load and the oncoming crush of old-age entitlement spending. 

      You raise an interesting thought: a cleaner code with lower top rates might reduce the deadweight losses and thus the overall tax burden even if the tax overhaul was revenue-neutral.  I'm not sure I buy that.   Taxes are a burden regardless of who pays them.   Also, our rate structure is still much flatter than it was before 1986, when the top rate was 50 percent. As a result, there's less leeway for dramatic rate reductions.  In fact, I suspect tax burdens need to go up for many middle-income families, who currently pay very little federal income tax. 

     Certainly, tax  hikes won't solve the problem.  They probably aren't even the main solution.   But they have to be part of the equation, and there's no point in sugarcoating that.













Looking at numbers

Let me be empirical:

There are many estimates of he deadweight cost of taxes. Feldstein is a credible as any and linkable. He says...

An across the board increase in personal tax rates involves a deadweight loss of 76 cents per dollar of revenue

That's from today's level. However...

[] CBO projects income tax rates will have to increase 50% by 2030 just to stay even with the rising cost of Medicare and Social Security.

By the "square" rule, that increases the DWC figure to $1.71 per dollar of revenue (with increases from there still projected forever).

[] As you say, "Aggregate revenue drain from tax breaks topped $1 trillion in 2009 and actually exceeded the total money collected from personal and corporate income taxes." So if tax expenditures were cut in half, tax rates could be reduced by one-third, while collecting the same amount of revenue.

Cutting rates one third would by the "square" rule reduce the 76 cents figure to 34 cents.

Now, apply those DWC amounts, 34 cents, 76 cents, and $1.71 per dollar of revenue, to the relevant amount of revenue in each case.

Too many people argue about tax policy as if it is some dispute between libertarianism and socialism.

The deadweight cost of taxes is nobody's friend.

You left a couple out...

From following the links, it appears that the Earned Income Tax Credit and the Childcare Tax Credit combine to almost $100 billion a year. Also, considering itemized deductions as tax expenditures without considering the standard deduction is a way of magnifying their benefit to high income tax payers; certainly the standard deduction must be the highest costing tax expenditure.

For that matter, having tax rates lower than the highest rate can be considered a tax expenditure as well; if all income from $1 paid the highest rate, tax revenues would soar.

Now, I actually agree that the best policy would be to broaden the tax base by eliminating most tax deductions; but labeling them 'tax expenditures' does not mean getting rid of them isn't a tax increase. Removing the mortgage interest tax deduction will be a huge tax increase, and will have a significant effect on the home values. As we are seeing, that has a very negative effect on banks and local governments.

Two more big ones

Tax deductible municipal bonds - why in the world should the federal taxpayer subsidize local debt?

Federal income tax deduction for state and local income taxes - why should a person making $200k in New York pay less federal income tax than one in Tennessee? Why should the federal tax payer subsidize high income taxes in states?

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