Feldstein on Tax Expenditures

Martin Feldstein has an interesting op-ed in today's Washington Post on tax expenditures. Tax expenditures -- the list of special tax credits, deductions, and exemptions written into the tax code -- constitute over $1 trillion in lost revenues every year and distort economic activity. In our recent paper on the deficit reduction plans, CRFB noted that a common theme among the plans was in reducing the tax expenditure budget (click here to read CRFB's plan for tax expenditure reform). Feldstein has his own unique and interesting approach.

Feldstein proposes capping the credits, deductions, and exemptions that individual taxpayers can use from itemizing, thus limiting the revenue impact of tax expenditures. In response to other proposals that cut or eliminate specific tax expenditures, or nearly all of them, he does not believe that it is politically feasible to do so as people would be strongly opposed to changes affecting them while others, benefitting other people, were left in place.

Feldstein uses the following example to illustrate his proposal:

"To be clear, the cap would not apply to the amount of any deduction but would limit the total tax savings that result from such deductions. Someone with a 25 percent marginal tax rate who pays annual mortgage interest of $4,000 would still deduct that $4,000. The cap would apply to the $1,000 tax saving that individual could expect on mortgage interest, not to his or her deduction. The idea is not to single out a particular tax expenditure."

Feldstein then uses the example of a cap on all tax expenditures equal to a person's adjusted gross income. Feldstein says that such a cap would reduce the deficit by $262 billion in 2011, which would be 1.7 percent of GDP or one third of the projected deficit. Doing so would move more people to the standard deduction which would thus simplify the tax code (the actual cap amount would thus be crucial in having the correct incentive effects). Feldstein notes that an additional dollar cap would have larger deficit reduction effects.

As Feldstein puts it:

The cap would not discriminate among taxpayers who benefit from various forms of tax expenditures. It would, however, reduce the deficit by hundreds of billions of dollars a year without raising tax rates and thus without reducing the incentive to work, to save or to expand businesses.

Overall, CRFB applauds Dr. Feldstein for his excellent idea on tax expenditure reform. We sincerely hope that if (hopefully "when") Congress gets around to deficit reduction, tax expenditures will be part of any plan.