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Bernstein: Tax Expenditures Offer a Useful Way Forward on Deficit Reduction

March 5, 2013 at 11:31 PM

In testimony today before a Senate Budget Committee hearing, CBPP Senior Fellow Jared Bernstein explained why reforming tax expenditures (tax deductions, exclusions, and other tax breaks) “should offer a solution palatable to both sides” in the ongoing debate over reducing deficits.  Here’s an excerpt:

[I]t is clear that compromise on a deficit-reduction package is blocked by seemingly intractable disagreements about the composition of such a package.  Republicans have argued for a “spending-cuts-only” approach while the Presidents and Democrats in this chamber have argued for a package that balances spending cuts and tax increases.

Tax expenditures sit astride both of these categories, because while they are administered through the tax code, many serve the same function as spending programs.  Thus, those who believe we have a spending problem should also believe we have a tax expenditure problem.  At the same time, since tax expenditures currently forgo over $1 trillion in revenue each year that would otherwise be in the tax base, their reform offers significant contributions to a balanced deal.

Of course, just as not every spending program should be cut, neither should all tax expenditures be repealed or reduced.  In discussing examples below, I use three criteria to evaluate the utility of tax expenditures:  revenue forgone, efficiency, and fairness.  Members will not be surprised that it is far too easy to find many tax expenditures that are “trifectas”:  they forego significant revenue, they induce inefficiencies, and they return most of their benefits to the wealthiest households, boosting after-tax inequality and failing on the fairness criterion.

I cannot overemphasize the importance of this last point regarding fairness.  As I point out below, not only do we have record high levels of income and wealth inequality in America, but changes in our tax code over the last decade have often exacerbated those inequalities with certain tax expenditures, like favorable treatment for capital gains and opportunities to defer taxation on appreciated assets, contributing to that outcome.  These issues took center stage in the last election and President Obama frequently cited a fairer tax code as a central part of his agenda.

In my own work on these issues, I’ve raised concerns about how taxpayers view the legitimacy of the American tax system.  If the average taxpayer feels like the privileged can get a much better deal out of the tax code than they can, that system’s legitimacy is at risk, and this is a serious concern for a democracy.  In that sense, these revenue issues are not merely about cash flow and budget balancing.  They are existential.

Click here for the full testimony.