NCPA - National Center for Policy Analysis

How to Cut the Deficit without Raising Taxes

November 30, 2010

A critical feature of the proposal recently unveiled by Erskine Bowles and Alan Simpson, the cochairmen of the president's bipartisan fiscal commission, is to reduce tax expenditures rather than raise tax rates.  That would increase revenue without reducing incentives to work, save or invest, says Martin Feldstein, a professor of economics at Harvard University and president emeritus of the nonprofit National Bureau of Economic Research.

Because Bowles and Simpson recognize that eliminating all tax expenditures is politically impossible, they also proposed to eliminate or scale back some tax expenditures while cutting tax rates less to achieve the same $80 billion annual deficit reduction.  This option will undoubtedly be opposed by some who find it unfair to limit measures from which they benefit while leaving unchanged tax rules that benefit other people.

Here is a practical alternative toward the same end:

  • Congress should cap the total benefit taxpayers can receive from the combined effect of different tax expenditures.
  • That cap could be set as a percentage of an individual's adjusted gross income and perhaps subject to an absolute dollar amount.

The budget gain would be substantial.  

  • Feldstein and colleague Daniel Feenberg have estimated that capping an individual's benefit from tax expenditures at 2 percent of adjusted gross income would reduce the federal deficit in 2011 by $262 billion, or about 1.7 percent of gross domestic product.
  • An additional cap on these benefits in absolute dollar terms would produce a larger deficit reduction.

Capping the benefit of tax expenditures at 2 percent of adjusted gross income would prompt many of those who itemize to shift to the standard deduction, a major tax simplification.  The individual cap would also reduce some of the economic inefficiency now caused by the tax system since individuals subject to the cap would not have any tax-driven incentive to do more of the capped activities, says Feldstein.

Source: Martin Feldstein, "How to Cut the Deficit without Raising Taxes," November 29, 2010.

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