I’m a little obsessed with tax expenditures. In Grand New Party, Ross and I wrote about how many analysts are misled by the role of tax expenditures in shaping the American welfare state. I first encountered this argument in Christopher Howard’s The Hidden Welfare State. (The argument is ably summarized at Wikipedia, though perhaps some Wikipedia vandal will edit in some kind of elaborate fan-fiction.) While other advanced democracies engage in explicit spending, we use various tax breaks and tax credits to reward certain behaviors and punish others. So while it looks as though the government is giving you your money back, they’re only giving it to you if you use it to buy health insurance. That doesn’t sound like much of a concession to me.
But because tax expenditures aren’t explicitly seen as spending, we’ve allowed them to mushroom, and give the government an ever-expanding ability to micromanage our decisions. When you factor in tax expenditures, the American welfare state is comparable in size to those of continental democracies. It’s just that our welfare state is less transparent, and more of the resources are directed to affluent households that don’t need the money.
With that in mind, Len Burman has proposed a freeze on tax expenditures that would do far more to curb deficits than a freeze on non-security domestic discretionary spending.
Suppose Obama’s “freeze” were also applied to tax expenditures. Say we postponed its effect until fiscal 2013 so that the effects do not threaten a nascent economic recovery. Capping tax expenditures at 2012 levels for three years and indexing the cap for inflation after that, as proposed for non-security discretionary spending, would reduce the deficit by about $3.5 trillion. That’s right — 14 times as much as what the president’s spending freeze would save.
He also makes a strong conservative case for curbing tax expenditures.
Tax expenditures have proliferated in large part because they enable politicians to promote their pet causes while appearing to lower taxes. But tax expenditures require higher tax rates to cover their cost, just like direct expenditures, and they impose higher burdens on those who don’t share in the benefits. A study published in 2008 found that eliminating all individual income tax expenditures would permit a 44 percent across-the-board cut in tax rates without reducing revenue. The top marginal rate could drop from 35 percent to 20 percent. Conservatives could stand up and cheer.
Conservatives might also take note because tax expenditures are mischaracterized as tax reductions rather than spending, so the federal government appears to be much smaller than it really is. And the expenditures require the kind of top-down regulation from Washington that conservatives scorn.
My sentiments exactly.