SALON

Wednesday, Jan 2, 2013 10:58 PM UTC

The real way to fix the deficit: Stop coddling the rich

Instead of cutting aid to the poor, the president and Congress should focus on reforming costly tax expenditures

By

Topics: Next New Deal, Tax Policy Center, Barack Obama, Mitt Romney, Affordable Care Act, ,

The real way to fix the deficit: Stop coddling the richHouse Speaker John Boehner (Credit: Reuters/Jason Reed)
This originally appeared on Next New Deal.

Next New Deal While we often hear critics decrying the redistributive effects of American social spending, government aid does not always benefit households of limited means. Often, aid looks more like a million-dollar vacation home or a luxury health insurance plan than housing vouchers and food stamps. American social spending is more complex than a simple redistribution from high- to low-income households. Over time, the country’s tax and transfer system has adopted provisions that reward specific high-income households. These programs contribute to deficit growth and detract from spending targeted at alleviating poverty among working families.

The most generous social welfare programs are currently administered through the tax code. A list of itemized deductions on households’ income tax returns serves as the only indication of these benefits. Income tax deductions, exclusions, deferrals, and credits, known collectively as “tax expenditures,” amount to more than $1 trillion of federal spending (according to estimates by the Tax Policy Center), not including lower tax rates on capital gains and dividends to encourage investment.

Tax expenditures are the functional equivalent of direct spending. Consider two households with identical incomes of $200,000. Household A purchases a home with a mortgage. Household B rents an apartment. Household A likely receives $5,000-10,000 (depending on mortgage size and APR) through the mortgage interest deduction when filing taxes. Household B receives $0. This, in effect, is a subsidy for homeownership. If the IRS collected taxes without any exclusions or deductions and then distributed payments to those who purchased mortgages, we would most likely categorize this disbursement as a form of direct spending.

Beyond simply diminishing revenues, tax expenditures disproportionately favor high-earning households, thereby reducing progressivity of federal income taxes. One reason for this imbalance is that high-income households have relatively high marginal income tax rates. Consider the exclusion of $10,000 of earned income for two individuals. Taxpayer A is taxed at a rate of 20 percent. Taxpayer B is taxed at a rate of 35 percent. Excluding $10,000 means removing this sum from taxable income. Decreasing taxable income by $10,000 for both of these individuals will yield $2,000 for Taxpayer A and  $3,500 for Taxpayer B. Thus, two taxpayers who engage in identical behavior receive disparate rewards because of income differences.

High-earning households are also more likely to engage in behaviors incentivized through the tax code. This means that, in addition to gaining more from each dollar deducted from tax obligations, high-earning households also deduct more than their middle- and low-income peers. Having more resources, the top 20 percent of households are more likely to purchase homes and contribute to retirement savings plans than households in the bottom 20 percent. They are more likely to hold jobs that offer employer-provided health insurance. Further magnifying the divide, high-income households on average possess more expensive employer-provided health insurance. In subsidizing purchases of homes, retirement plans, and health insurance for all households, tax expenditures disproportionately assist those originally more likely to engage in these behaviors. Consequently, high-income households are in better positions to take advantage of tax deductions.

So if tax expenditures waste essential potential revenues on affluent households, why are they so difficult to reform? General support for simplifying the tax code is not difficult to find. What is difficult, however, is reducing or eliminating particular benefits that households already possess. Tax expenditure reform would be tantamount to a tax hike on households that itemize deductions. For this reason, politicians enthusiastic about tax code simplification become reticent when faced with the task of eliminating specific loopholes.

The first step to simplifying the tax code successfully is treating tax expenditures as spending. This distinction demands that Congress scrutinize expenditures to the same degree that it scrutinizes antipoverty spending. Congress should consider whether particular deductions or exclusions successfully incentivize a desired behavior. Further, it should assess whether social rewards from altered behavior exceed revenue lost. For example, it would be difficult to argue that any social gain from deducting mortgage interest on second homes for families earning more than $250,000 exceeds revenues lost. By simultaneously reducing revenues for means-tested entitlements and subsidizing home purchases of wealthy taxpayers, such a provision merely exacerbates income and wealth inequality. This provision is not worth revenue losses that it engenders.

While tax expenditures for high-income families would not survive this level of scrutiny, some expenditures for low-income families achieve desirable ends. This social value justifies revenues lost. For example, the Earned Income Tax Credit (EITC) supports low-wage workers with supplemental income, reducing the poverty rate for these workers and their families. EITC successfully incentivizes work, achieving a valuable social aim and warranting a degree of spending. Other existing expenditures might also be continued for lower- and middle-income households. For example, Congress might continue the mortgage interest deduction for low- and middle-income households on the margin of being able to afford homeownership. But Congress should only adopt such extensions if a clear argument can be made that social gains exceed revenues lost.

As President Obama and congressional leaders continue to negotiate long-term deficit reduction, the first programs that they trim should be those subsidizing high-income households. More than any other social spending category, tax expenditures for high-income households constitute frivolous spending. Both presidential candidates in 2012 supported reducing tax expenditures for high-income families. Governor Romney suggested setting a maximum deduction, while President Obama proposed setting deductions at lower tax rates. Each of these plans would limit tax expenditures for high-income households to some extent. In order to further decrease tax expenditures’ regressive effects, these proposals could be combined with reforms that target payments toward lower- and middle-income households. This would include restricting the mortgage interest deduction to primary residences and limiting exclusions for luxury health insurance beyond provisions already included in the Affordable Care Act.

Now it is time for the president and Congress to fulfill their promise to simplify the tax code, beginning with those at the top of the income scale. While tax expenditure reform for high-income households will not solve our fiscal problems single handedly, it represents an essential path forward for reducing the deficit without exacerbating the economic hardship of low-income Americans.

More Joe Landry.

Next Article

Related Stories

More Related Stories

Featured Slide Shows

The week in 10 pics

close X
  • Share on Twitter
  • Share on Facebook
  • Thumbnails
  • Fullscreen
  • 1 of 11
  • Lisa Montgomery embraces her nephew Thursday after a tornado tore apart her home in Cleburne, Texas. The twister killed six people and destroyed entire swaths of the North Texas town.
    Credit: AP/LM Otero

  • Jack McMahon, the defense attorney for abortion doctor Kermit Gosnell, speaks outside the Criminal Justice Center in Philadelphia Tuesday. His client was convicted of killing three babies in his clinic, and will serve multiple life sentences.
    Credit: AP/Matt Rourke

  • A photo taken Monday captures Vice President Joe Biden's response to a Milwaukee second-grader's innovative proposal to end America's epidemic of gun violence. This guy!
    Credit: AP/Jenny Aicher

  • Sen. Rand Paul, R-Ky., flanked by a grouper-eyed Michele Bachmann, addresses the IRS' admission that it targeted Tea Party groups in advance of the 2012 election. In an op-ed for CNN Thursday, the Kentucky senator slammed the president for his faux outrage.
    Credit: AP/Molly Riley

  • Ousted IRS chief Steven Miller is sworn in on Capitol Hill Friday. Miller testified before the House Ways and Means Committee on the extra scrutiny the agency gave conservative groups applying for tax-exempt status.
    Credit: AP/J. Scott Applewhite

  • Attorney General Eric Holder pauses as he testifies on Capitol Hill before the House Judiciary Committee Wednesday. Holder is under fire, among other things, for the Justice Department's gathering of phone records at the Associated Press.
    Credit: AP/Carolyn Kaster

  • O.J. Simpson sits during an evidentiary hearing at Clark County District Court in Las Vegas, Nev., Thursday. Simpson, who is currently serving a nine-to-33-year sentence in state prison for armed robbery and kidnapping, is using a writ of habeas corpus to seek a new trial.
    Credit: AP/Las Vegas Review-Journal/Jeff Scheid

  • Major Tom to ground control: On Sunday astronaut Chris Hadfield recorded the first music video from space, a cover of David Bowie's "Space Oddity."
    Credit: AP/NASA/Chris Hadfield

  • When it rains it pours. President Barack Obama speaks during a news conference Thursday with Turkish Prime Minister Recep Tayyip Erdogan, inexplicably inspiring an #umbrellagate Twitter meme.
    Credit: AP/Jacquelyn Martin

  • A smoke plume rises high above a road block at the intersection of County A and Ross Road east of Solon Springs, Wis., Tuesday. No injuries were reported, but the the wildfire caused evacuations across northwestern Wisconsin.
    Credit: AP/The Duluth News-Tribune/Clint Austin

  • Recent Slide Shows

  • Share on Twitter
  • Share on Facebook
  • Thumbnails
  • Fullscreen
  • 1 of 11

Related Videos

Comments

 25 Comments

Comment Preview

Your name will appear as username

You may use these HTML tags and attributes: <a href=""> <b> <em> <strong> <i> <blockquote>

Salon is proud to feature content from Next New Deal, the blog of the Roosevelt Institute. The site features current news, fresh insight and sharp analysis aimed at reanimating progressive thought.

follow salon

Most Read

Popular on Reddit

links from salon.com

vote
Loaded terminology like "entitlements" and "welfare" skews the debate and alters America. How right-wingers use semantic tricks to kill government.
352 points353 points | 116 comments
vote
How right-wingers use semantic tricks to kill government -- "...much of the U.S. economic security support system consists of subsidies for the affluent in the form of tax breaks, like those for private retirement savings plans such as 401(k)s and private employer-provided health insurance."
66 points67 points | 3 comments
vote
Doug Henwood: Capitalism Thrives on Class Exploitation
40 points41 points | 4 comments
vote
Temple Grandin on DSM-5: “Sounds like diagnosis by committee.” When it comes to autism, Grandin argues we're paying too much attention to labels -- and not enough to individuals
37 points38 points | 2 comments
vote
Temple Grandin on DSM-5: “Sounds like diagnosis by committee.” When it comes to autism, Grandin argues we're paying too much attention to labels -- and not enough to individuals
36 points37 points | 3 comments

From Around the Web

Presented by Scribol
listener_new_rect The Listener: So long, Sookie Stackhouse

Recommendations