RSS Feed MenuPresident Barack Obama’s speech on deficit reduction left a lot to be desired: his agenda offers too many goodies for his party’s base, an excess of unworkable class-warfare- “tax the rich” platitudes, and too few real spending cuts. All that said, the President is right about one major thing: the desirability of “reducing tax expenditures so that there is enough savings to both lower rates and lower the deficit.”
Republicans are wrong to consider any elimination of any tax expenditure as a tax hike. In fact, many tax expenditures—although not the most expensive ones—ought to be considered spending programs that true fiscal conservatives should investigate with the same careful eye they apply to other programs.
Crudely, it’s possible to divide tax expenditures into two categories: those that will benefit just everyone and those that are actually just special favors handed out via the tax code. Quite simply, eliminating a tax expenditure in the first category should be considered a tax hike while eliminating one in the second category shouldn’t.
The mortgage interest, state/local tax, and health care deductions should and could fairly be considered broad-based features of the tax code. Efforts to limit, cap or repeal them should, for those who support lower taxes, be paired with efforts to cut rates elsewhere. After all, everyone pays some state or local tax, everyone needs health care, and almost everyone buys a home at some point. Elimination of these revenue expenditures will have the same consequence, roughly, as raising marginal rates.
The great bulk of other revenue expenditures (which are much less fiscally significant than the big ones noted above), however, should fairly be treated as spending programs. Breaks handed out to people who buy new HVAC systems, produce ethanol, or drive hybrid cars are simply spending by another name. So are special benefits handed out to the working poor (the Earned Income Tax Credit) and blind people (an additional personal deduction).
These are simply ways of using the tax code to reward very particular groups or behaviors. They have no impact one way or another on taxes for the great majority of people; eliminating or limiting them can’t fairly be considered a tax hike at all. Getting rid of them will have consequences more similar to a spending cut: it will reallocate resources from the government-preferred purpose to a purpose determined by market forces.
This doesn’t mean, of course, that all narrow revenue expenditures are bad while the other broad ones are good. In fact, I’d argue that the Earned Income Tax Credit is the best and most effective social welfare program in the country while the size and scope of the mortgage interest deduction ought to be limited. Nonetheless, all revenue expenditures deserve a close look. And efforts to eliminate the narrower ones simply shouldn’t be considered tax hikes.
ottovbvs // Apr 15, 2011 at 7:55 am
And corporate tax breaks?
JeffreyGoldfarb // Apr 15, 2011 at 8:25 am
I have a dream that the U.S. will have a serious debate about its pressing social and economic problems. I am a liberal, looking for intelligent Republican thinking. Pleased to see this piece. But on the other hand, such thinking would brighten Republican prospects. Unlike the Ryan approach, which just about assures Obama’s re – election, http://www.deliberatelyconsidered.com/2011/04/obama-wins/, this would present a real challenge.
ggore // Apr 15, 2011 at 8:29 am
Question for the Republicans who say rich people don’t need to pay taxes because they create jobs for poor people: Just who are the people who have shut down factories and plants and moved the jobs to China, Pakistan, India, Mexico, or wherever? Poor people? Small business owners? Or the mega-rich CEO’s the Republicans refuse to tax? Their program of reducing taxes on these people has worked like a charm so far, the ultra-rich have closed their factories at a record pace and moved millions of jobs overseas. They received the benefits of the Bush tax cuts and proceeded to close even more plants and sent millions more jobs out of the U.S. And STILL the Republicans expect us to buy into their mantra of NEVER taxing the rich. This is one voter who will NOT be buying into that fantasy scenario at the next election!!!
PatrickQuint // Apr 15, 2011 at 10:11 am
Eli Lehrer:
Damn straight. The tax code is the other half of the budget, where the many of the shady corporate giveaways are hiding.
Rabiner // Apr 15, 2011 at 10:20 am
Eli:
“So are special benefits handed out to the working poor (the Earned Income Tax Credit) and blind people (an additional personal deduction).
These are simply ways of using the tax code to reward very particular groups or behaviors. They have no impact one way or another on taxes for the great majority of people; eliminating or limiting them can’t fairly be considered a tax hike at all. Getting rid of them will have consequences more similar to a spending cut: it will reallocate resources from the government-preferred purpose to a purpose determined by market forces.”
You had me until this line. Last I checked, the Earned Income Tax Credit would apply to everyone if they were poor at one time or another (yet you seem to think buying a home falls into a more palatable category). So your argument is the government is encouraging people to be poor with the Earned Income Tax Credit. Impressive thinking.
“This doesn’t mean, of course, that all narrow revenue expenditures are bad while the other broad ones are good. In fact, I’d argue that the Earned Income Tax Credit is the best and most effective social welfare program in the country while the size and scope of the mortgage interest deduction ought to be limited. Nonetheless, all revenue expenditures deserve a close look. And efforts to eliminate the narrower ones simply shouldn’t be considered tax hikes.”
You come back to logic here, but still fail since you don’t revert your original thinking regarding which category home interest deductions should fall it versus the Earned Income Tax Credit.
Adam Washington // Apr 15, 2011 at 10:22 am
Mr. Frum, I agree with you on the need to cut “tax expenditures,” but the President proposes nothing specific–as usual. Yes, he is for motherhood, apple pie, hope, and change, but don’t expect proposals that might offend anyone except the “rich.”
ottovbvs // Apr 15, 2011 at 1:34 pm
Simply not true. If anyone is operating in bumper sticker land it’s yourself.
valkayec // Apr 15, 2011 at 10:24 am
The tax code has over a $1 Trillion/yr in tax expenditures. They should all be looked at in the context of rewriting the entire tax code to simplify it and make it more efficient. Many of the tax expenditures distort the market and reduce competition or entry into the market while giving huge advantages to large players. That’s simply not a “free market.”
I wish the GOP and Norquist would get that through their heads.
Frumplestiltskin // Apr 15, 2011 at 10:36 am
Breaks handed out to people who buy new HVAC systems, produce ethanol, or drive hybrid cars are simply spending by another name. So are special benefits handed out to the working poor (the Earned Income Tax Credit) and blind people (an additional personal deduction).
True this.
except for the needless opening obligatory Obama swipe this was a very nicely argued piece of writing, I am not sure why Eli would want people rolling their eyes right off the bat with that atrocious first line.
“an excess of unworkable class-warfare- “tax the rich” platitudes” Not this shit again. He simply wants to allow the Bush tax cuts, which had sunset provisions, to expire while continuing the poor and middle class tax cuts, but if Eli wants this “class-warfare” angle to be dismissed then I say let all the tax cuts expire. And Eli knows damn well that is the best option to getting the financial house in order. I guess he would still call it class warfare on the rich, I think if Republicans could they would be delighted to tax to death the poor and middle class and exempt the rich from all taxes (as they advocate a 0% Capital gains tax rate)
Anyway, I digress so Eli, if you have a point to make…make the point otherwise it gets obscured when you annoy people with needless opening digressions
dante // Apr 15, 2011 at 10:45 am
I’ve said it before and I’ll say it again, we use the tax code to push people to do things that we want them to do. You may not agree with that, but eliminating those deductions means that people won’t have any incentive to do them.
Child-tax-credit: Encourages people to have children (or lessens the expense of doing so), so that we don’t have massively declining birth rates like Japan.
Mortgage interest deduction: Encourages people to buy a house, because a home-owning population is more stable and more profitable (or so the prevailing wisdom goes).
Student loan interest deduction: Encourages people to get an education, because an educated populace is more productive and earns more.
401(k)/IRA deduction: Encourages people to save more for their own retirement, instead of relying on SS.
So before we start talking about eliminating deductions, we should ask ourselves why they are there in the first place and what social affect removing them will have.
Jim in DE // Apr 15, 2011 at 1:36 pm
Totally agreed, dante, I am not one to so dismissively remove all deductions from the tax code. (Though, full disclosure, I am a tax attorney.) I don’t know if I agree that we’re incentivizing childbirth … I don’t know if anybody really considers the tax advantage of having another child when making that decision. I may have just led a sheltered life. The mortgage interest deduction though, that’s a big one to take away. For all the people who have already lost 10 to 20 percent of the equity in their home in the last 3 years, eliminating that deduction will only exacerbate the problem, even if you grandfather in existing mortgages. If we were starting from scratch, the desirability of subsidizing home ownership could be the subject of strong debate, but I feel like that ship has sailed now.
There’s a definite benefit to encouraging productive behavior (like employment and charity) and discouraging damaging behavior under the tax code. The problem there arises if the IRS has to branch out to perform functions that it is not fit to do, like monitoring the validity of everyone’s health care plan under ACA or, as we saw a few weeks ago, validating that someone taking a credit for buying a hybrid actually bought a hybrid.
Frumplestiltskin // Apr 15, 2011 at 10:53 am
dante, Eli does, he mentions favorable the EITC.
Let me also add that Eli is also making the point that the mandate to buy insurance is essentially a tax. If you buy insurance you get a tax break or you can frame it the opposite, if you don’t buy insurance you get a tax hike.
Rabiner // Apr 15, 2011 at 11:09 am
Dante:
“Mortgage interest deduction: Encourages people to buy a house, because a home-owning population is more stable and more profitable (or so the prevailing wisdom goes).”
Except when that house is unaffordable by the person buying it. Which will occur more often due to tax incentives to make the purchase in the first place.
sublime33 // Apr 15, 2011 at 12:12 pm
No mention of the tax breaks that companies like Verizon and Exxon Mobil receive either. Is Verizon going to stop providing so much phone service or is Exxon going to stop refining so much gasoline if their tax breaks are lifted?
ottovbvs // Apr 15, 2011 at 1:46 pm
These tax breaks are not going to disappear to any substantial extent because they all have constituencies to defend them. The deficit problem is going to be substantially disposed of by two mechanisms.
1)Economic growth
2)The Expiration of ALL the Bush tax cuts. Regardless of whether Obama wins or loses the election he’s in a position to just let them expire and the Republicans have no mechanism for reinstating them because even under the best scenario for them they aren’t going to have the presidency, the house and the senate with a supermajority. Obama is likely to win re-election and if he does Republicans will pressure him by doing a reprise of holding the tax cuts for the middle classes hostage to tax cuts for the wealthy. By then the economy will be in good shape, he’s in his last term, and so he won’t need to make a deal. Ergo they will ALL expire and he can blame the Republicans.
think4yourself // Apr 15, 2011 at 2:15 pm
I appreciate Eli’s willingness to consider tax exemptions versus a Grover Norquist knee-jerk response. I’d being willing to take a serious look at all deductions (not sure that the earned income tax credit and child tax credit provides a lot of support for the poor, but I could be wrong).
I am probably the only one who wants to take a stab at the mortgage deduction. I believe that it subsidizes buying either (a) unreasonably large houses or (b) houses with esoteric mortgages that front-load interest – i.e. the mortgages that helped fuel the recession. Right now, we all get a standardized deduction – I think it’s about $12,000 for joint filers. The itemized deduction covers several items, but almost always mortgage interest is the big one (I’m not a tax attorney but review hundreds of tax returns every year for my business). The other two are state or other taxes and charitable giving.
So the mortgage deduction doesn’t encourage us to buy a home, it rewards us for having lots of interest expense. Meaning it rewards us for excessive debt. I looked at a tax return today that had $137,000 in home mortgage interest for someone who had $145,000 in total income. He got a great deduction that rewarded bad behavior (buying a 7 figure, 11,000 sq. ft. house when making under $150K per year).
No one will cut the mortgage interest deduction because it is a sacred cow. I think if there ever was a time to do it, that time is now.
sublime33 // Apr 15, 2011 at 3:02 pm
I think one reason that mortgage interest has always remained a deduction is because that for decades, too many homeowners get the highest mortgage dollar that the lenders would let them get away with. And the maximum monthly payment calculation factors in the deductability of the interest and property tax. Take away the deductability and the allowable monthly payment goes down, which depresses the overall market and upsets the sellers. And the sellers are a huge political force. If they think that a new tax law is going to hurt the resale value of their house, which it likely will, they are going to fight tooth and nail against the change. And I can’t blame them.
think4yourself // Apr 15, 2011 at 4:24 pm
I understand the argument. The fact is the real estate and mortage industry have been using the “buy a house because you need the deduction argument” as a selling tool for years, but for most people, that’s not really the case.
For example: Assume a home purchase of $250,000 with 10% down finance $225,000 at 5% interest for 30 years = $1,208 per month. The interest deduction year one is about $14,400 or not much greater than if you take the standard deduction. Where we get into trouble is people buying (and financing) much larger home purchases. What we are really subsidizing is the financing of McMansions. If someone wants to buy one they can, but why should we as a nation subsidize that purchase?
Rabiner // Apr 15, 2011 at 4:26 pm
Think4yourself:
“So the mortgage deduction doesn’t encourage us to buy a home, it rewards us for having lots of interest expense. Meaning it rewards us for excessive debt. I looked at a tax return today that had $137,000 in home mortgage interest for someone who had $145,000 in total income. He got a great deduction that rewarded bad behavior (buying a 7 figure, 11,000 sq. ft. house when making under $150K per year).”
That’s not terrible behavior in my opinion. If you earn 1/10th of the value of the home, that’s reasonable. You can pay off the home in 20 years at a decent living standard most likely. But it does encourage you to buy a bigger house than you normally would of.
sublime33 // Apr 15, 2011 at 5:17 pm
“That’s not terrible behavior in my opinion. If you earn 1/10th of the value of the home, that’s reasonable”
No, that is outright radical. Someone earning $40,000 a year should own a $400,000 home? The rule of thumb used to be a maximum of three times your annual income. Not ten times.
Cindyflo // Apr 15, 2011 at 6:21 pm
Buying a 7 figure house when you make under $150k a year isn’t bad behavior – but giving someone making under $150k a 7 figure mortgage is. That said, in many parts of the country the $250k home think4yourself mentioned is a joke. In the Seattle area, for example, starter homes are $400k…
Rabiner // Apr 16, 2011 at 2:30 pm
Cindyflo:
Hit the nail on the coffin. I work in real estate now and I can see why someone would buy a home for 10 times their annual salary in metropolitan areas. Earning 60k a year I think I can afford a home thats in the 500k-600k if I put 10-15% down to start. Sure if you drop that figure to 40k a year and its a 400k home the values begin to become worse since a person with 40k salary has a much lower budget for housing than a person with a 60k budget. Actually that difference is upwards to 15k a year if you want to keep all other costs (besides taxes) the same.
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