Navigating the Tax Expenditures Minefield
July 26, 2011
Reducing tax expenditures appears to be the only mechanism able to satisfy both sides in the ongoing debt ceiling debate, as it offers a way to generate additional revenue while leaving effective marginal tax rates unchanged. The problem with this basic formula is that no one is sure what a tax expenditure really is, says Economic Policies for the 21st Century.
Everyone seems to agree that a tax expenditure is spending that takes place through the tax code through exclusions, deductions and credits that are tantamount to government outlays. Unfortunately, this general definition does not square with the fact that the one area where actual spending through the tax code occurs -- refundable tax credits, which allow households to receive checks from the government in situations where they owe no income tax -- is not classified as a tax expenditure.
- Perhaps the diciest definitional issues arise when everyone agrees that a certain tax policy is a tax expenditure, but some lawmakers propose eliminating it in a way that is tantamount to a tax increase.
- This appears to be precisely the situation that exists today, as President Obama is proposing a reduction in the "rate" applied to deductions for certain higher income taxpayers.
- First off, it is important to realize that there is no "rate" applied to deductions, there is only a rate applied to income.
- The tax rate applied to the itemized deductions of middle-income families is exactly the same as the deductions made by high-income families -- zero.
- The rate at which the deducted dollar would have been taxed is irrelevant for determining whether or not the deduction itself is legitimate.
- A deduction does not suddenly become an affront to economic-neutral tax policy because it is claimed by a household with a gross income in excess of $200,000.
Source: "Navigating the Tax Expenditures Minefield," Economic Policies for the 21st Century, July 8, 2011.
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