Tax Reform: The Next Big Thing in the Federal Budget Debates – Amelia Kegan

The fiscal cliff ended with a deal that raises about $620 billion in new tax revenue over the next decade. Some say that the tax decisions were made and behind us. But for those of us who care about our country’s ability to address hunger and help people move out of poverty, the fiscal cliff deal cannot be the last word on revenues. As Congress struggles to find another one to one and a half trillion dollars in deficit reduction, we absolutely need more revenues if programs that reduce hunger and poverty are to remain effective and funded.

Congress has enacted significant deficit reduction over the past two years, but the vast majority of it has come from spending cuts—73 percent, in fact. If the rest of the $1.2 trillion (the figure many economists agree is needed to stabilize the debt) comes from equal parts spending cuts and revenue increases, cuts still would outpace revenue 2 to 1, excluding interest savings. Alternatively, if the rest of the $1.2 trillion comes from spending cuts alone, then we’re looking at a ratio of 5 to 1—far less balanced than all the major bipartisan commissions and groups over the past two years, including the Bowles-Simpson Commission, the bipartisan Gang of Six (later the Gang of Eight) in the Senate, and the Rivlin-Domenici Commission. Most of these groups recommended something closer to a ratio of one to one, spending cuts to new tax revenue.

More revenues are needed, but what are the options after the fiscal cliff deal? Officially titled the American Taxpayers Relief Act, the fiscal cliff deal answered many of the questions raised by the Bush Tax Cuts expiring. With marginal income tax rates, capital gains tax rates, the estate tax, and a number of other rates set, most of the formerly outstanding questions are no longer up in the air. Given that we just went through a big fight on what the top marginal tax rate should be and at what income level it should start, Congress probably does not have the appetite to return to that debate.

Where does the tax conversation go from here?

Tax expenditures—deductions, exemptions, and credits often referred to as “tax loopholes.” And the way to get at tax expenditures is through tax reform. Taxes may seem like one of the most controversial and partisan topics, but there is a lot of bipartisan agreement on this front. There is general agreement that the tax code is too complex. There is bipartisan agreement that tax expenditures constitute spending through the tax code. Many of these loopholes don’t actually influence behavior and often benefit people and industries that don’t need it. Furthermore, just complying with such a complex tax code is extremely inefficient and leads to all sorts of unnecessary costs.

There are many benefits to reducing tax expenditures. First, tax expenditures are overwhelmingly regressive, disproportionately benefitting high-income individuals. A wealthier individual gets a larger benefit from a $100 charity donation than a low-income family does from that same $100 donation. The current structure of deductions means that the government essentially subsidizes 36 cents of every dollar given to charity for someone earning enough to be in the top tax bracket. On the other hand, the government only subsidizes 10 or 15 cents of every dollar given to charity for someone in the lower tax brackets. An analysis by the Center on Budget and Policy Priorities shows that 66 percent of all tax expenditure benefits go to the wealthiest 20 percent of Americans, with the richest 1 percent receiving 24 percent of the benefits. In contrast, while the middle 60 percent of households receive 31 percent of the benefits, and the bottom 20 percent of households receive just 3 percent of the benefits.

Second, tax expenditures are wasteful, make the tax code less efficient, and impede economic growth. The regressive or “upside-down” nature of most tax expenditures means they often give the biggest subsidies to the people who would most likely take the desired action anyway without the added incentive—buy a house, save disposable income, etc. Furthermore, all these tax expenditures make the tax code extremely complex. Individuals and businesses end up spending time and resources complying with the various complicated provisions of the tax code, sifting through the different deductions, exclusions, and credits to make sure they’re getting all potential benefits. This is a waste of time and resources, which could be going towards more productive avenues that generate economic growth.

Third, there are few opportunities for Congress to evaluate and review the effectiveness of various tax expenditures. Former chairman of the Federal Reserve, Alan Greenspan, referred to tax expenditures as “tax entitlements.” The Government Accountability Office has recommended that, “All federal spending and tax policy tools, including tax expenditures, should be reexamined to ensure that they are achieving their intended purposes and designed in the most efficient and effective manner.” Currently, once a deduction or exclusion is enacted into law, Congress doesn’t regularly review the benefit as it does with spending policies. Most federal programs are reviewed every year through the appropriations process. Even entitlement programs have to be reauthorized periodically.

Finally, tax expenditures cost the government a lot of money, roughly $1.1 trillion every year. This is about three-quarters of what the federal government will actually collect in income taxes this year according to the Center for American Progress. It’s more than Social Security, both Medicare and Medicaid, and all defense spending, which cost $725 billion, $755 billion, and $699 billion respectively, according to the Center on Budget and Policy Priorities.

Members of Congress must get past one major policy disagreement.  Will legislators use tax reform to raise revenues for deficit reduction (revenue positive) or will they use the revenue generated from closing tax loopholes to give more tax cuts (revenue neutral)? Given the fiscal realities, tax reform should be revenue positive. The country cannot afford another round of Bush Tax Cuts, especially in light of the tax fights we just went through on the fiscal cliff.

We must be aware that resolving this issue doesn’t mean smooth sailing for the rest of the tax reform debate. While there is general agreement that we simplify the tax code and get rid of or tone down tax expenditures, that’s easier said than done. Almost every tax deduction, exemption, and credit is backed by a powerful interest group. Just look at the home mortgage interest deduction or black liquor.

In stark contrast, those few credits that benefit low-income working populations usually receive the most scrutiny. Unlike other tax expenditures, the current Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) benefit levels are not permanent and will expire in five years. These are two of the country’s largest and most effective anti-poverty programs. The U.S. Census Bureau estimates that in 2011, the EITC lifted 5.7 million people out of poverty, including 3.1 million children. These credits have seen a variety of improvements over the past decade, but they were all set to expire along with the rest of the Bush Tax Cuts at the end of 2012. While Congress made most of the tax cuts permanent, they only extended the current EITC and CTC benefits for five years. Still, continuing just the 2009 improvements will help over 13 million working families, including 25.7 million children, in 2013 alone.

Yet, because of political power, these critical anti-poverty tax measures are far more vulnerable in the tax debate than those tax expenditures that benefit politically powerful interest groups. I remember a couple years ago, discussions began over whether Congress should enact a tax on sugared beverages. This was not a formal proposal or legislation, merely discussion. Immediately, the beverage industry put up television ads denouncing the idea. Low-income working families cannot put up television spots or fly to Washington to push back against proposals that would curb or cut the EITC and CTC.

How do we ensure tax reform supports a national commitment to addressing hunger and poverty? As the Senate Finance Committee and House Committee on Ways and Means move forward on tax reform, they should adhere to a few basic principles:

1. Tax reform must generate new tax revenue;
2. Tax reform should explicitly protect and make permanent the current Earned Income Tax Credit and Child Tax Credit benefit levels;
3. Low-income families should not face a higher tax burden resulting from tax reform; and
4. At the least, tax reform should maintain the current progressivity of the tax code.

Amelia Kegan is a Policy Analyst at Bread for the World and well-known tax expert within the interfaith community.  She is also co-chair of the Interreligious Working Group on Domestic Human Needs.  She can be reached at akegan [at] bread [dot] org.