If you want to wave a red flag in front of a fiscal conservative, just announce you are in favor of raising taxes. If you want to see steam puffing out of that conservative’s ears, mention that current tax revenues are not covering what Congress is spending much less helping to reduce the debt. “Government has no right to my money”, huffs those Uncle Scrooges.
Without a doubt, tax policy is an inexact science. One hand levies taxes and the other hand grants loopholes, exemptions, and outright tax credits. Most people like the loopholes, exemptions, and credits, and like even more the politicians who provide them. Raising taxes generally draws less applause even from progressives, unless of course those higher taxes are on the rich. How then does the country get its fiscal house in order?
Recently the New York Times reviewed a government report which listed the estimated 2013 budget impact of tax code exclusions, deductions, and credits. Would you believe the amount added to over $1 trillion?
Hold that thought. There are over $1 trillion in exclusions, deductions and credits in a budget that projects collection of only $1.3 trillion in individual income taxes!
And consider that the projected 2013 deficit (on the same basis) is $800 billion. Without exclusions, deductions and credits, the budget could produce a surplus and begin reducing the debt.
So it should be easy to to balance the budget, right?
Take a look at a partial list of exclusions, deductions, and credits (published in the NYT). The three big hitters are “employer contributions to health care insurance”, “pension and 401K contributions by employers”, and “reduced tax rates on dividends and capital gains”. These three add up to over $400 billion. That is equal to about 1/3rd of the $1.3 trillion in federal income tax actually collected.
But who is not for health care and retirement? The reduced rate on dividends and capital gains is a little more contentious. Health care and retirement affect everyone while a tax break on dividends and capital gains is highly skewed in favor of wealthy Americans.
Most Americans like the mortgage deduction as well as deductions for State, Local, and property taxes. And saving taxes with charitable gifts seems wholesome. The earned income credit also targets an economic class, the poor. Who will be the first to take a shot at eliminating this deduction?
Here’s the list.
- Employer contributions for health care $147.8
- Pension and 401K contributions by employers 147.0
- Value of Medicare benefits 73.1
- Exclusion of capital gains at death 43.9
- Benefits like flexible spending accounts 39.6
- Untaxed Social Security and Railroad retirement benefits 39.2
- Interest on Municipal Bonds 38.2
- Investment income on life insurance and annuities 29.6
- Capital gains on sale of home 26.1
- Veterans benefits 7.0
- And many more…
Deductions and reduced tax rates
- Reduced rate on dividends and capital gains $110.4
- Mortgage interest deduction 89.6
- State and local tax deductions, including property taxes 68.8
- Charitable deductions 46.9
- Individual retirement accounts (IRAs) 19.2
- And more
- Earned Income credit for low-income workers 58.1
- Children under 17 25.7
- And more
It is clear that the tax code plays a large role in fostering private and social goals. Healthcare, retirement, and raising some Americans above the poverty level are examples. The tax code also encourages home ownership and investment in a wide range of enterprises. That the tax code is complicated is an understatement.
So when we hear our politicians cry out that they are for eliminating loopholes, exemptions, and credits, think about this $1 trillion list of exclusions, deductions, and credits shown above. Who would you trust to pare them back?
A reasonable person could reach the conclusion that it might be a fruitless task trying to cut back much of this $1 trillion given there is something in the tax code for everyone. Reductions in government spending are, for sure, part of the formula but they will also encounter the special interest protection.
So, one comes face to face with the only tool left, the first steps towards fiscal sanity must be in the direction of greater tax revenues built in part upon higher tax rates. Reductions in spending along with cuts in exclusions, deductions, and credits can and should follow. The questions are when, where, and for how much?