Capping Tax Expenditures a Substitute for Raising Taxes

February 25, 2013

Both Republicans and Democrats agree that deficits must be cut, though the former emphasizes cuts to government spending and the latter champions raising revenues. In order to accelerate the economy, putting a cap on tax expenditures would result in massive savings, says Martin Feldstein, a professor at Harvard University.

  • Tax expenditures are a substitute for direct government spending granted through tax credits or tax deductions.
  • The largest tax expenditures are deductions that individuals can take on their tax returns for mortgage interest, state-income and local-property taxes paid.
  • There are also exclusions from taxable income from municipal bond internet and for employer-provided health insurance.

By limiting tax savings from all deductions and the two major tax exclusions to 2 percent of an individual's adjusted gross income, the deficit could be reduced by $220 billion in 2013. The 2 percent cap refers to the tax savings, not to the amounts of the deductions and exclusions.

  • The 2 percent cap would also maintain existing deductions for all charitable contributions and would allow employees to exclude the first $8,000 of employer-paid health insurance premiums, which would amount to $141 billion in tax savings in 2013.
  • The combined savings would total $2.1 trillion.
  • The 2 percent cap solutions highlights that raising taxes are not necessary to raise revenue.

Instead of raising taxes, part of the $2.1 trillion could be used to lower tax rates, which will promote economic growth. The 2 percent cap should be politically viable, since it treats all tax expenditures equally. To lessen its immediate impact on an already weak economy, the 2 percent cap could be introduced gradually as a 5 percent cap.

A combination of capping tax expenditures and reforming entitlement programs would reduce the national debt and stabilize the long-term U.S. financial outlook.

Source: Martin Feldstein, "A Simple Route to Major Deficit Reduction," Wall Street Journal, February 20, 2013.

 

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