If revenues are to be in the budget package that the President and Congressional leadership are now negotiating—and be in there, they must—they will almost surely come from cutting tax expenditures. Those are the one trillion worth of tax revenues forgone each year due to tax breaks for various activities in the code.
Politicians of both parties recognize that many of these tax breaks are loopholes, as seen in the vote a few weeks ago to end the $6 billion annual tax subsidy for ethanol, which garnered 34 R’s in the Senate.
There’s even a little list going around town of tax expenditures that might get cut in the deal, including oil and gas subsidies, favorable tax treatment for inventories (why should the tax code favor inventories?…like I said, loopholes), and other cats and dogs (corporate jets!).
The thing is, back in April, when President Obama set out his budget guidelines for this aspect of the talks, he said he wanted a cool trillion in revenues, out of deal that reduced deficits over 12 years by $4 trillion.
So, connecting all these dots, it seemed like a good idea to think about various ways to get to a trillion in savings through cutting tax expenditures. Here’s a menu, with rough cuts of the savings over 10 years.
|Tax Expenditure||Billions over 10 Years|
|End the favorable tax treatment of inventories||53|
|Close Carried Interest Loophole||15|
|Eliminate Preferences for Fossil Fuels||46|
|Reform International Tax System||129|
|Tax Stock Dividends Like Regular Income||125|
|Raise Both Cap Gains and Dividends Tax to 28%||140|
|Eliminate the Mortgage Deduction on Second Homes||60|
|Itemize Deductions @28% for Incomes>$250K||321|
|Itemize Deductions @15% for Incomes>$250K||900|
|Itemize Deductions @15% for All Incomes||1,200|
|Eliminate Itemized Deductions for >$1 mil||475|
|Phase out the Mortgage Interest Deduction Over 10 Years||750|
|Sources: Don’t Ask…(CBO, Fiscal Commish, Obama FY12 Budget, my calculations)|
As noted, these are rough estimates from a variety of sources but they’re ballpark. You can’t tote up the whole list without double counting, because reducing itemized deductions covers all of the other individual components in the table. But the point is we could theoretically get to $1 trillion in savings over 10 years in lots of ways, and many of these are obviously dialable.
We could raise $1.2 trillion by only allowing people to itemize deductions at a 15% rate instead of the top rate they face. This would obviously be a big deal—most of this stuff would be a big deal—but as my CBPP colleague Chuck Marr points out, in terms of fairness, why should a wealthier person get bigger breaks for their deductions than a middle-class person. And don’t conservatives like flat taxes?
I’m not endorsing all of these. Economists legitimately worry that the mortgage interest deduction distorts prices in the housing market, but it remains a bedrock tax break to a lot of middle-class families (44% of the value of deductions goes to families with incomes less than $100K), and you actually couldn’t get rid of that distortion without whacking home prices, something you’d kinda want to avoid right now.
Others should be a slam dunk. The so-called “carried interest” loophole allows hedge fund managers to pay the capital gains rate (now 15%) on their earnings, so they end up paying a lower rate than a middle-income school teacher.
The point is we could stick to tax expenditures and hit the $1 trillion in revenue the President wisely laid out at the beginning of this process. I’m not saying we will. Just sayin’ we could.
Comments on Kudlow: Never watched him before. I find him annoying.
Is the US Greece? No. I’m glad you came back to this point.
Can Greece end up leaving the euro? Yes.
Basically, “Greece doesn’t have a plan for growth. In fact, they are raising taxes.”
Greece is being forced to enact austerity measures as a condition of their loans. And yes, taxes can be contractionary, but all taxes are not the same. The ones requested of Greece are too severe: too fast, too much.
They didn’t even understand your liquidity versus solvency point….
They don’t understand the basics of sovereign debt crises. It’s not possible to have an intelligent conversation with people who don’t know what they’re talking about.…
You made really good points. Good job being patient and clear.
And I agree that the timing on the mortgage interest deduction is important, but I still think it needs to be phased out. Also, from a demographic perspective (the link I shared earlier today), I think it’s entirely doable and makes sense.
The mortgage interest deduction is one of the few deductions still available to the middle class. In my case it’s probably the only way that I can afford to stay in my home. I think that any effort to eliminate this deduction would likely be political suicide for whichever party initiates the process. I understand that it may be an archaic deduction but it is one that the middle class identifies with and considers an important part of the equation when deciding on home affordability.
It’s hard to see how trying to implement a change like this could have anything but a disastrous effect on housing prices at a time when all efforts should made to at least stabilize the market.
Homeowners have taken a huge hit as a result of the recession and even those of us who tried to act responsibly but who lost our jobs and saw the value of our biggest asset reduced by 20 or 30% are in no position to help republicans with their hissy fit.
I totally understand your point, and I sympathize with homeowners (esp middle class and lower income), but see this is the thing. There is a good argument that the deduction creates distortion in the housing market and can contribute to a housing bubble, which when it bursts (which it eventually will), creates much more wealth destruction than the gain from the deduction. The amount of equity in US homes has fallen by over half, from about $15 trillion to $6 trillion from 2006 to 2010 because of the burst of the bubble.
This isn’t healthy: bubbles and busts. And it can also have disastrous effects on the broader economy as we’ve seen.
Also, as Prof. Bernstein points out above, over 50% is not going to the “middle class.” I think depending on the cutoff a, good argument could be made that most of it goes to the upper classes.
I think to offset the pain on the middle class, they could offer other tax credits or deductions that do not potentially create distortions in the housing market, which especially after the growth in securitization, has become tied to the financial sector. The combination of bubbles can clearly be catastrophic.
So although I get where you’re coming from, thinking about it from all the different angles may help put it in perspective. And I definitely agree with you on the timing.
Another great post by Bernstein, congrats!
Mary, I side with Mike. Currently the deduction is limited to interest on loans up to $1 million, which is ridiculously high and could be reduced by half or more without causing pain to the middle class. There is no rationale for subsidizing the purchases of McMansions and real mansions, but I believe it’s good for communities to have strong rates of home ownership rather than relying on absent landlords who in many cases are large corporations with priorities that differ from a typical homeowner.
I agree with you that the interest deduction was, in part, a contributor to the housing bubble. As a matter of fact because of a divorce I had to refinance in 2006 and against my better judgement took on a larger mortgage (70% of appraised value) than I planned. Based partially on the interest deduction it was still affordable, just didn’t factor in my employer of 35 years relocating to Europe.
Having said that, the mortgage interest deduction has been around since 1913 and doesn’t seem to have been indicted in any other housing bubbles so I think that, again we have only the total lack of responsibility on the part of the banking industry to blame for the bubble.
Does it still belong in the Tax Code? I’m a chemist not an economist and I’ll defer to those of you I consider to be the “good guys”in this argument. My point tonight is that politically and economically it could be a disaster on top of a disaster to have this discussion now. Prof. Bernstein suggested a 10 year phaseout which seems reasonable but the clock really shouldn’t start until the economy and housing markets have been stabilized for a reasonable amount of time.
Despite the fact that over 50% of the deduction goes to the upper class, there is still a huge part of the middle class for whom this deduction may be as treasured as Social Security or Medicare.
If the Mortgage Interest Deduction had anything to do with the bubble then it was a marginal bit player. Targeting it while letting the bankers go free is adding insult to injury.
Well said Fr33. Getting rid of this deduction (as opposed to reducing the deduction limit) should be LAST on any list. I can “get to a trillion” without it and, indeed, I can greatly exceed that amount without touching the three largest numbers (1200, 900, 750) on Bernstein’s excellent list. And I almost certainly would support doing exactly that over other proposals to reduce the budget.
NO NO NO NO NO NO NO
The housing bubble was caused by speculation in the housing markets, which was caused by exactly one, only one, and thoroughly one thing:
we let the banks speculate on owner-occupied housing.
That’s it. If we had not let them do that, then they would not have done that.
I follow the points here and believe they are important, but my head is spinning from several other factors.
Yesterday, JB explained that the longer the debt discussions play out, the higher the interest rates will be on the debt. This was news to me; it’s not part of my normal day to worry about such things. It occurred to me at the time that someone was quite likely wanting to manipulate the budget negotiations, but I figured it was someone on Wall Street.
I then clicked over to Financial Times, which as of Mon pm (PST) had a new headline about rising interest rates for US debt — if the debt ceiling conversations continued to be unresolved. (This is my offhand recollection, so take with a grain of salt.) I thought, “Hmmmmm, that’s mighty powerful confirmation of what JB’s blog just posted.”
Just now, about 24 hours later, I was watching Dylan Ratigan’s MSNBC program. In a segment about the national debt and spending priorities, Ratigan got practically bug-eyed and announced that he has information that Eric Cantor is *short* on U.S. Treasury Bonds (!).
How is this possible…?!
I may be recently off the turnip truck, but that’s basically ‘insider trading’: take a financial position, then manipulating the outcome in order to produce a result that will enable you to clean up financially!
It’s criminal and disgusting when this happens in businesses, but doing it on a federal budget is completely jumping the shark.
I’m turning into an ‘indignado’, American suburban style.
Why should we even be talking about tax breaks if one of the people making these decisions is taking short positions on Treasury Bonds?!
That is insider trading.
And it is insider trading on the sovereign debt of the US!
My head is spinning.
Close Carried Interest Loophole
Tax Stock Dividends Like Regular Income
Raise Both Cap Gains and Dividends Tax to 28%
Those three are perhaps the most stimulating to the economy, IMHO. They will drive money back in corporations with real investments instead of buying back stocks, and paying out huge amounts of money to the top management.
Along with the 750B from phasing out the Mortgage Interest Deduction you also get the pride of knowing that fewer people will be able to afford buying houses, and those now holding on to their homes may not be able to afford it anymore.
Could you discuss Capital Gains taxes and its impact on the economy.
I’ve been trying to sort this issue out with very mixed results.
I suspect most of the articles in favor of low capital gains rates come from right wing think tanks. I know how they operate but am unsure of their overall effect on the economy. I suspect Hedge funds use them and offset short term losses with long term gains somehow.
I have read some information by Joseph Stiglitz so I know what he thinks. I also suspect the overall contribution to tax revenue contributed via capital gains is small (10%) so that all the talk about the effect of low capital gains rates is the result of money from special interests (probably renteirs), but I’m not really sure.
Is there a typo here or is this supposed to be 43%. I am not an economist, but this does seem a bit confusing…
Itemize Deductions @28% for Incomes>$250K 321
Itemize Deductions @15% for Incomes>$250K 900
Please enlighten me!
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No typo. It’s just that if you only let the $250K+ folks deduct 15 cents on the dollar vs 28 cents, you collect a lot more revenue.
Doesn’t the list then seem to count that deduction twice? Once at one rate and one at another? Is that what the author meant by an “estimate?”
They aren’t summed at the end, this was just a “menu” listing each possible option. You could garner $321B with one option or $900B with the other. Some can be combined, others can’t.
We met some years ago when you and I almost co-wrote a book on economics for social workers but you were too busy with other things so I ended up going with another co-author. It’s nice to connect with you again. Here is my comment. If you decrease the itemized deduction percentage, this may result in fewer charitable contributions, including those to non-profits that work with vulnerable populations. This, presumably, would be in addition to decreased funding for such organizations resulting from cuts in public support for them, which seems to be a big part of the current budget/debt ceiling talks. Is this something you’re worried about and, assuming that it is, have you thought of a way to address this problem?
[…] or new taxes on oil companies and other businesses, we could get more revenue still. Economist Jared Bernstein, formerly of the Obama Administration and now of the Center on Budget and Policy Priorities, […]