How to cut taxes
It's time to toss some popular tax credits that really just help the rich.
Michael R. Strain is a resident scholar at the American Enterprise Institute.
The tax break for homeowners isn’t very progressive. (Paul J. Richards/AFP)
Jeb Bush heads to New Hampshire, rallying support for a potential presidential bid. Hillary Clinton is fighting allegations of improper behavior. Ted Cruz announces he’s running for president and releases a campaign video – in Spanish. Nineteen long months until the general election, and the 2016 primary season has begun. Meanwhile, amid the hubbub over emailgate. another potential 2016 GOP contender, Sen. Marco Rubio, along with Sen. Mike Lee, unveiled a tax plan. kicking off a conversation — on both the left and the right — about tax reform.
All of which means we’re in for a debate about where we want the tax code to go. Here’s a start: We should spend less money through the tax code on the rich and use some of the savings to encourage work and reduce poverty among low-income Americans.
The tax code includes many provisions that result in lost revenue by granting special tax treatment to specific activities. These provisions, which seek to advance various social goals, are substitutes for direct federal spending programs and are called tax expenditures — spending that occurs through the tax code. And we’re not talking about peanuts; we spend more money through the tax code than we spend on national defense.
Many tax expenditures are obscure. But several are familiar to large swaths of Americans, including the mortgage-interest deduction.
The deduction is designed to advance the social goals of homeownership for families and stability for communities by making homeownership more affordable. But rather than simply cutting a check to every home owner, the government takes less money from home owners when they file their taxes. Taking less, of course, is a substitute for spending more — the mortgage-interest deduction, obviously a subsidy, is properly considered federal spending.
Who benefits from this subsidy? People rich enough to own their homes, but especially those who own large, expensive homes. The nonpartisan Congressional Budget Office (CBO) estimates that in 2013, the mortgage-interest deduction cost a whopping $70 billion, nearly three-quarters of which accrued to households with income in the highest 20 percent of the population, with 15 percent going to the top 1 percent.
The mortgage-interest deduction is hardly unique in its distributional effects. According to CBO’s estimates, in 2013, more than half of the tax benefits from the 10 costliest tax expenditures were enjoyed by households in the top 20 percent. Seventeen percent of the benefits accrued to the top one percent.
We should move the tax code away from spending money on high-income Americans. The best way to do this would be to examine the list of tax expenditures, item by item, and eliminate (over time) the ones we don’t like. For example, I would phase out the mortgage-interest deduction and the tax exclusion for employer-provided health care but would keep the tax deduction for charitable contributions and the child tax credit.
Alternately, we could follow economist Martin Feldstein’s proposal to limit each household’s combined benefits from a specified set of
tax expenditures to a certain share of its income.
Either way, we should spend less money on the people who need it the least.
What to do with the extra revenue from spending less on high-income Americans? We should use much of it to lower tax rates as a way to encourage work and investment, with the goal of faster income growth. We should also use some of it to reduce projected deficits. Remember, we’re talking about hundreds of billions of dollars a year; there’s a lot we can do.
And here’s one more: We should use some of the money to encourage work among low-income Americans. Only four in 10 high-school dropouts have a job, compared to seven in 10 college graduates. The reasons for this massive disparity are many, but surely a major factor is the low wages less-educated Americans can command in today’s labor market.
One way to solve this problem is to use federal money to supplement the earnings of low-income workers. Specifically, we should expand the Earned Income Tax Credit (EITC). The EITC is a federal earnings subsidy to low-income households. The basic idea is simple: If you work and your household earns below a certain amount, the government cuts you a check to supplement your earnings.
This program operates through the tax code, just like the mortgage-interest deduction. But unlike the deduction, it is targeted to help low-income Americans: Previous expansions of the EITC have pulled significant numbers of jobless Americans into the workforce. And the EITC lifts millions of people, including children, out of poverty.
The EITC is much more generous to households with children than to households without children. For example, a household with three children can receive a maximum subsidy of about $6,000, while a childless worker maxes out at a little under $500. The maximum EITC benefit for childless workers should be expanded. President Obama has proposed an expansion that would cost roughly $6 billion a year. Rep. Paul Ryan (R-Wis.) has a similar proposal .
We could completely fund a significant EITC expansion for childless workers with less than one-tenth of the revenue from eliminating the mortgage-interest deduction, still leaving plenty of money to lower tax rates and reduce the deficit.
Of course, altering the tax code to spend relatively less on the well off and more on the needy, lowering tax rates, and reducing the deficit are far from the only goals of tax reform. We should also move away from an income tax and toward a consumption tax, significantly lower the corporate tax rate, and keep in mind projected spending on middle-class entitlements, being careful not to add to the already massive projected deficits our nation will face in the years to come.
The purpose of the tax code is to raise the revenue needed to finance government activity. But the shape of the code says something about the character of the nation. An appropriate goal of tax policy is to support the aspirations of the American people — encouraging work and helping low-income Americans to earn their own success in the labor market.
Spending less through the tax code on high-income Americans would be a good step toward advancing that goal.Source: www.washingtonpost.com