A Special 10/40
In the spirit of Tax Day today the Bottom Line presents its own special “10/40” (don’t worry; we aren’t filing this with the IRS).
Just saying the term “taxes” sends a shiver down one’s spine. We equate them with death and likewise avoid discussing the topic. As such, even though Tax Day is here, the fiscal discussion in Washington has been driven by a myopic focus on spending. The fact is that revenues are also a part of the federal budget equation and must have a prominent role in the conversation on how to get our fiscal house in order. Instead of death and taxes, we should be talking about debt and taxes, as well as spending. While you were assiduously avoiding the topic a great deal has transpired in the tax front.
A new paper from CRFB observes the top 10 tax policy developments of the past year. One of the biggest issues has been the growing prevalence (and increasing scrutiny of) tax expenditures. Below is a summary of the top 10 tax policy developments that are examined in more detail in the paper, along with a list of the top 40 tax expenditures, thus, 10/40.
Top 10 Tax Policy Developments of the Past Year [See a fuller description of each development here]
10. Record Low Revenue and Higher Spending in the Tax Code
Federal revenue has declined to its lowest level as a share of the economy (14.9% of GDP) since the mid point of the last century while tax expenditures—the exclusions, exemptions, credits, preferences and deductions that reduce tax liability and, thus, decrease revenue—have increased to over $1 trillion.
9. Senators Wyden, Gregg, and Coats Lead the Charge for Fundamental Tax Reform
If you think you have procrastinated when it comes to taxes, Congress has been particularly lax in addressing the subject. The last major reform occurred in 1986, but a few senators helped change the debate in Washington by putting forth bipartisan, comprehensive tax reform legislation that streamlines the tax code and broadens the tax base while lowering rates by eliminating many tax expenditures.
8. The 2010 Tax Deal Where Everyone Got Something (And Charged it to the National Credit Card)
A legislative stalemate over renewing the 2001/2003 tax cuts was resolved in December, not by compromising in the middle or finding ways to offset the costs, but by adding even more to the deficit—sacrificing fiscal responsibility in the name of political expediency. Compromising federal finances is not the type of breakthrough we need.
7. The Disappearing, Reappearing Estate Tax
The estate tax was in a state of flux last year. The so-called “death tax” lived up to its name when the tax itself died in 2010, only to be resurrected in 2011.
6. The VAT Gets Voted Down
Although a number of tax experts have called on the United States to augment (and/or partially replace) its income tax with a consumption tax, last April the Senate voted 85-13 on a “Sense of the Senate” against a Valued-Added Tax (VAT).
5. The Making and Breaking of Tax Pledges
A recurring theme through the year has been how tax pledges from politicians have constrained policy choices for lawmakers and obstructed the way for sensible policy reforms. Pledging what one will not do makes negotiation and collaboration much more difficult by taking options off the table at the outset.
4. Non-Story of the Year: Politicians Patched the Alternative Minimum Tax
Every year lawmakers enact an “AMT patch” to keep the AMT from hitting more people, and do so at great cost to the Treasury. This year, as part of the 2010 tax deal, policymakers extended AMT patches for another two years—adding about $140 billion to the deficit.
3. CUTGO Cuts Out PAYGO
One of the major rules changes undertaken by Republicans after they took control of the House involved replacing the “pay as you go” (PAYGO) rule with a new “cut as you go” (CUTGO) rule. Not only does it make it harder to pay for new legislation, but it leaves the door open for budget-busting tax cuts.
2. Not “Making Work Pay” Anymore
When the stimulus bill was enacted in 2009, CRFB and others were worried that many of the supposedly-temporary provisions in the legislation would be made permanent. Yet, in a rare occurrence in Washington, the “Making Work Pay” tax credit ended last year.
1. The “Zero Plan” Offers a Way Forward
The National Commission on Fiscal Responsibility and Reform (Fiscal Commission) zeroed in on tax expenditures with a sweeping tax reform proposal known as the “Zero Plan.” The idea behind the Zero Plan was to wipe out all tax expenditures in the code, set aside money for deficit reduction, and then lower tax rates as much as possible.
Top 40 Income Tax Expenditures Going Forward
| Rank | Tax Expenditure |
Projected Cost 2012-2016 (Millions $) |
|---|---|---|
| 1 | Exclusion of employer contributions for medical insurance premiums and medical care | 1,071,210 |
| 2 | Deductibility of mortgage interest on owner-occupied homes | 609,180 |
| 3 | Step-up basis of capital gains at death | 357,080 |
| 4 | 401(k) plans | 356,260 |
| 5 | Exclusion of net imputed rental income | 302,800 |
| 6 | Deductibility of nonbusiness state and local taxes other than owner-occupied home | 292,290 |
| 7 | Accelerated depreciation of machinery and equipment (normal tax method) | 269,680 |
| 8 | Capital gains (except agriculture, timber, iron ore, and coal) | 256,280 |
| 9 | Deductibility of charitable contributions, other than education and health | 248,930 |
| 10 | Employer plans | 245,970 |
| 11 | Exclusion of interest on public purpose state and local bonds | 230,440 |
| 12 | Capital gains exclusion on home sales | 216,820 |
| 13 | Deferral of income from controlled foreign corporations (normal tax method) | 212,840 |
| 14 | Deductibility of state and local property tax on owner-occupied homes | 142,290 |
| 15 | Exclusion of interest on life insurance savings | 129,060 |
| 16 | Social Security benefits for retired workers | 129,040 |
| 17 | Keough plans | 103,880 |
| 18 | Exception from passive loss rules for $25,000 of rental loss | 83,750 |
| 19 | Deduction for U.S. production activities | 82,000 |
| 20 | Individual Retirement Accounts | 80,490 |
| 21 | Exclusion of benefits and allowances to armed forces personnel | 65,500 |
| 22 | Deductibility of medical expenses | 60,020 |
| 23 | Child credit | 49,200 |
| 24 | Earned income tax credit | 45,060 |
| 25 | Social Security benefits for disabled workers | 41,240 |
| 26 | Exclusion of workers' compensation benefits | 40,940 |
| 27 | Self-employed medical insurance premiums | 38,840 |
| 28 | Credit for low-income housing investments | 36,070 |
| 29 | Expensing of research and experimentation expenditures (normal tax method) | 35,080 |
| 30 | Exclusion of veterans death benefits and disability compensation | 30,850 |
| 31 | Exclusion of income earned abroad by U.S. citizens | 30,500 |
| 32 | Lifetime Learning tax credit | 28,620 |
| 33 | Deductibility of charitable contributions (education) | 28,300 |
| 34 | HOPE tax credit | 28,280 |
| 35 | Deductibility of charitable contributions (health) | 28,110 |
| 36 | Exclusion of interest on hospital construction bonds | 26,760 |
| 37 | Credit for employee health insurance expenses of small business | 20,640 |
| 38 | Inventory property sales source rules exception | 18,770 |
| 39 | Graduated corporation income tax rate (normal tax method) | 17,840 |
| 40 | Exclusion of interest on bonds for private nonprofit educational facilities | 17,710 |
Source: Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2012, Office of Mangement and Budget.
So, what can we expect for tax policy moving forward? In the immediate future the role of revenue in reducing the national debt will be a critical and hotly-contested debate. Calls for fundamental tax reform will steadily grow. The term “tax expenditures” (or perhaps “tax earmarks”) will increasingly become a part of the public lexicon as scrutiny intensifies and bipartisan support for addressing them solidifies. And quarreling over renewing the 2001/2003 tax cuts will heat up during the campaign season. Hopefully, by this time next year we will be able to talk about how comprehensive tax reform became reality.
