Tax Reform: A Trap That Could Generate Bigger Deficits and More Inequality

Tax expenditures
Source: Matt Yglesias

It almost sounds reasonable. “Let’s broaden the federal income tax base by eliminating or reducing tax expenditures,” right-wingers suggest. But then they say, “We’ll make it revenue-neutral by cutting tax rates, especially for the wealthiest Americans!” This kind of tax “reform” would increase both deficits and inequality.

Chuck Marr and Chye-Ching Huang, writing for the Center on Budget and Policy Priorities, explain why this is a risky proposal (PDF):

[W]hile cutting “tax expenditures” sounds appealing in the abstract, cutting specific tax expenditures enough to offset the costs of substantial new rate cuts and contribute meaningfully to deficit reduction would likely prove difficult, if not impossible, to achieve. Indeed, the difficulty of cutting popular tax expenditures — from the mortgage interest deduction to 401(k) tax preferences to the deduction for charitable contributions to the exclusion for employer-sponsored health insurance — is why those who urge policymakers to commit upfront to specific, large rate cuts rarely specify any tax expenditures to cut. In fact, they often highlight tax expenditures that they would refuse to touch, such as the preferential tax rate for capital gains.

Take a look at the pie chart above. “Broadening the tax base” would mean eliminating or reducing the exclusion of employer health insurance, exclusion of pensions, the mortgage interest deduction, the state income tax deduction, the exclusion of Medicare, and other tax expenditures that help the middle class stay out of poverty. And what about the tax breaks that help the poor? The earned income tax credit, child tax credit, and the deduction for charitable contributions would be eliminated.

The tax “reformers” always want to take one of the biggest tax expenditures, the preferential tax rate for capital gains and dividends, off the table because that benefits primarily the 1 Percent. The 1986 Reagan tax reform eliminated the preferential rate, but Congress quickly restored it.

Revenue-neutral tax “reform” would do nothing to solve the long-term deficit problem. First of all, the right-wing proposals for additional tax cuts that go beyond the Bush-Obama Tax Cuts For The Rich are not revenue-neutral. It would be impossible to enact enough tax expenditure cuts to come anywhere near offsetting the cost of the proposed big tax rate cuts. Secondly, tax rates are already at an historic low – this is the primary driver of deficits. More revenue is desperately needed, starting with the expiration of the Bush-Obama Tax Cuts For The Rich at the end of this year. But the Washington politicians and right-wing think tanks are already calling that “Taxmaggedon,” as if the restoration of the Clinton-era tax rates could be compared to the end of the world!

Let the Bush-Obama tax cuts expire, then we can talk about tax reform that does not benefit the rich and lead to higher deficits and more inequality.

More info:
Tax Reform Holds Promise, But If Not Done Carefully, Could Increase The Deficit and Inequality and Harm the Economy (PDF, Center on Budget and Policy Priorities)
The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base Broadening (PDF, Congressional Research Service)
The 2012 Long-Term Budget Outlook (Congressional Budget Office)

  1. #1 by brewski on June 26, 2012 - 3:01 pm

    Wow, the former Economic Policy Advisor to Senate Majority Leader Tom Daschle opines that we need to keep the tax code as complicated and favor-pandering as possible. In other words, he was a tax advisor to a tax cheat.

    Meanwhile, in Canada, our liberal and polite neighbors to the North, their capital gains tax rate is 50% of an individual’s tax rate, and their corporate tax rate is 15%.

    The deductions allowed in Canada include:
    contributions to Registered Retirement Savings Plans,
    union and professional dues,
    child care expenses

    You will note no deductions for local taxes, or mortgage interest.

    Their tax code is ranked #8 and ours is #69.

    Hmmm. He should go back and give better advice to the tax cheat.

  2. #2 by Richard Warnick on June 26, 2012 - 5:16 pm

    brewski–

    I’ll make you a deal. Support the Clinton-era tax rates and I will support elimination of the tax expenditures that mainly benefit the rich.

  3. #3 by brewski on June 26, 2012 - 8:43 pm

    Richard,
    Under your proposal, Warren Buffett’s taxes would not go up one penny. You have a fetish for nominal rates as opposed to actually collecting more revenue. Keep your eye on the big picture.

  4. #4 by brewski on June 26, 2012 - 8:45 pm

    I’ll make you a deal. We adopt Canada’s taxes word for word, we adopt their health care word for word, we adopt their budget word for word, we adopt their banking regulation word for word.

  5. #5 by Richard Warnick on June 26, 2012 - 8:56 pm

    brewski–

    I admire your altruism, stubbornly defending tax cuts that you will never benefit from yourself! Plus, you or your descendants will own the downside – deficits are deferred tax increases or budget cuts for the 99 Percent. And remember that rising inequality brings political/economic instability and sets us up for more financial sector crashes.

    If we taxed capital gains as income with a 39.6% top marginal rate you say Warren Buffet’s taxes would NOT go up? Explain please.

    Joel Slemrod, an economist at the University of Michigian and a former senior economic adviser to President Ronald Reagan: “High GDP countries are high tax countries.”

    The Case for Raising Top Tax Rates

  6. #6 by brewski on June 26, 2012 - 10:35 pm

    Tax cuts? What tax cuts? I never said anything about tax cuts. I also never said anything about deficits, rising inequality, etc. As I said, my tax plan would raise Buffett’s taxes by 150%. How is that a tax cut and how does that increase inequality and how does that increase the deficits and how come you never acknowledge the math and why are you so dishonest?

  7. #7 by brewski on June 26, 2012 - 11:06 pm

    Richard,
    You said:
    “I’ll make you a deal. Support the Clinton-era tax rates”

    I say:
    Bill Clinton cut the capital gains tax rate from 29 percent to 21 percent in 1997, and economic growth rose from an average of 3.1 percent to 4.5 percent per year.

    After the capital gains tax rate was cut in the United States in 1997, the government collected nearly twice as much revenue from capital gains taxes in the next four years as in the previous four years.

    When the tax rate on the highest incomes was 73 percent in 1921, that brought in less tax revenue than after the tax rate was cut to 24 percent in 1925.

    Economists say:

    http://online.wsj.com/article/SB10001424052748703296604576005322879781298.html

    http://www.humanevents.com/2012/05/08/raising-the-capital-gains-tax-will-not-lead-to-fairness-but-only-slam-us-job-creation/

  8. #8 by brewski on June 26, 2012 - 11:19 pm

    Your Joel Siemrod piece discusses the individual marginal rate on wages and ordinary income only. It seems to ignore the corporate tax rate and the capital gains tax rate which play an important role in decisions on investment particularly by firms rather than individuals.

    Your NYT pieces is written by someone with no background in economics or taxation at all.

    If you look at how tax policies have changes around the world, you will see that other countries have evolved their tax policies a lot over the last 30 years as they came to see how their policies from the 50’s – 70’s didn’t work. As a generalization the total package of new tax policies include:

    1. Lower corporate tax rates
    2. Lower capital gains tax rates
    3. Higher consumption taxes including taxes on general sales plus gasoline and electricity.
    4. Highish personal tax rates which are often double the corporate tax rates.
    5. Few loopholes and tax expenditures
    6. Territorial system

    This is true for Canada, pretty much all of Europe, and others.

    If we could move in that direction it would be a good start.

  9. #9 by Ronald D. Hunt on June 27, 2012 - 12:06 am

    Cap gains revenues and gdp where going up prior to the cuts in 1997, The revenue from cap gains more closely follows gdp growth rates then any tax hikes or cuts.

    Economists? WSJ?, humanevents?

    These people are partisan politically drive groups not to be trusted on face value.

    “successful readers every day with breakout digital offerings like RedState, the Newt Gingrich and Ann Coulter E-Letters and more.” — humanevents.com

    really?

    Here I will give yea better source!

    http://krugman.blogs.nytimes.com/2012/01/18/the-history-of-capital-gains-taxes/

    http://krugman.blogs.nytimes.com/2012/01/19/the-dubious-case-for-privileging-capital-gains/

  10. #10 by brewski on June 27, 2012 - 7:01 am

    The links I provided were from actual PhD’s in economics. I don’t know what your problem is with people who are actually knowledgeable on topics on which they speak.

  11. #11 by brewski on June 27, 2012 - 7:04 am

    The second Krugman piece does indeed show that capital gains has been taxed at around 25% for most of post-war history, except for the disaster of the late 70’s.
    My point proven.

  12. #12 by brewski on June 27, 2012 - 7:06 am

    Krugman:
    “Meanwhile, by taxing income at very different rates depending on how it manifests itself, we create huge incentives to manipulate income to make it come out in the favored form.”
    I totally agree, which is why my plan which I have repeated here many times has one rate for all kinds of income regardless of he nature of that income. And for that and for agreeing with Krugman I have been universally criticized by the uneducated lefties.

  13. #13 by Richard Warnick on June 27, 2012 - 8:04 am

    brewski–

    I’m glad you are now disavowing tax cuts for the rich. So you’re OK with the expiration of the Bush-Obama TCFTR at the end of the year, and we are in agreement on that point.

  14. #14 by cav on June 27, 2012 - 8:35 am

    Richard, you’re supposed to have forgotten that.

  15. #15 by cav on June 27, 2012 - 9:02 am

    Tax cuts for the rich on top of three jumbo jets full of pallets of $100 bills. My Grand-kids are seething – and they haven’t even been conceive, let alone passed through to this particular veil of wonderment.

  16. #16 by brewski on June 27, 2012 - 9:04 am

    I never once suggested ever a tax cut for the rich. You keep calling increasing Buffett’s taxes by 150% a tax cut for the rich. Those are your words not my words. I don’t know why you keep coming up with false descriptions and then trying to tell me what I said, which is not what I said. Are you taking tutorials on lying from Maddow again?

    We are not in agreement that it is a good idea to adopt any shitty tax system. Clinton’s tax rate on capital gains was 21%. He went all over Silicon Valley telling people how great low capital gains tax rates are. I was there.

  17. #17 by brewski on June 27, 2012 - 9:29 am

    Capital gains tax rates go up, revenues go down.

    Capital gains tax rates go down, revenues go up.

    http://manicbeancounter.files.wordpress.com/2010/05/image0011.gif

    Proven.

  18. #18 by Richard Warnick on June 27, 2012 - 10:11 am

    brewski–

    Do you support letting the Bush-Obama TCFTR 15% capital gains rate revert to 20% at the end of this year? Or do you think the rich deserve yet another tax cut? Where is the trickle?

  19. #19 by brewski on June 27, 2012 - 11:38 am

    None of the above.

  20. #20 by Ronald D. Hunt on June 27, 2012 - 4:43 pm

    I don’t see any correlation their, not that correlation equals causation anyway.

    Growth in cap gains revenue seems to more closely match up with bubbles and the crashes that follow them, then the rate of the tax.

    All 3 major spikes in your chart match up with the 1986 Reagan crash, the 2001 dot com bust and the build up to the 2007 Bush Crash.

    All 3 major spikes in the rate are part of a trend that exists prior to the rate cut, further indicating their is little relation.

    Data does not include information about yearly corporate profits, GDP, market trends, foreign vs domestic origin of cap gains collected, effects of other unrelated policy on corp profits.

    And frankly the data set is small, 2 hikes, and 5 cuts give us a very wide margin of error that makes any assumptions about their effect some what silly.

  21. #21 by brewski on June 27, 2012 - 4:59 pm

    1986 crash?

    2001 crash?

    2007 crash?

    We must have different calendars.

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