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Reducing Tax Expenditures Must Be Central to Tax Reform, Says Conrad

MAR. 9, 2011

Reducing Tax Expenditures Must Be Central to Tax Reform, Says Conrad

DATED MAR. 9, 2011
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March 9, 2011

 

 

I want to welcome everyone to the Senate Budget Committee. Today we will focus on spending in the tax code, or tax expenditures as they are known. These are the countless credits, deductions, and exclusions that riddle and complicate the tax code. Specifically, we will examine the distribution of benefits and the efficiency of tax expenditures.

Our distinguished witnesses today are: Robert Greenstein, the President of the Center on Budget and Policy Priorities; Robert McIntyre, the Director of Citizens for Tax Justice; and Scott Hodge, the President of the Tax Foundation. Thank you all for being here. We look forward to your testimony.

Our nation is at a critical juncture. We are borrowing about 40 cents of every dollar that we spend. Spending is at the highest level as a share of our economy in more than 60 years. Revenue is the lowest it has been in 60 years as a share of the economy. Both sides of the ledger are part of the problem, I believe, and both have to be part of the solution.

Looking at revenues in isolation has led some to argue that revenues should be held to the historical level over the past 40 years -- about 18 percent of GDP. But revenues at that level would not have produced a single balanced budget in 40 years.

In fact, on the five occasions when the budget has been balanced or in surplus since 1969, revenues have ranged between 19.5 percent and 20.6 percent of GDP. It is this higher level of revenue that provides, I believe, a more useful guidepost for what is needed if we hope to dig ourselves out of this fiscal hole and set the budget on a sustainable path. Unlike in previous years, the country now faces an unprecedented demographic challenge, which will put a tremendous added strain on the budget going forward.

I believe that tax reform has to be part of the solution to addressing our fiscal problems, coupled with spending cuts. The current state of the tax code is simply indefensible. Our tax code is out of date and hurting U.S. competitiveness. It is hemorrhaging revenue to offshore tax havens and abusive tax shelters. The tax code is riddled with expiring provisions. This creates enormous uncertainty for citizens and businesses alike, making it very difficult for them to plan ahead. If we took steps to simplify and reform the tax code, we could reduce tax rates below where they are today. And tax reform would also allow us to raise more revenue to help address the very serious debt threat hanging over America.

Eliminating or scaling back tax expenditures should be at the heart of any tax reform we consider. This year, we will spend $1.1 trillion on tax expenditures. That's as much as all of discretionary spending, including defense. That is roughly equivalent to the size of our deficit. The deficit this year is going to be $1.5 trillion; tax expenditures are $1.1 trillion. It is a staggering sum by any measure. And these tax expenditures receive far too little scrutiny. I am a member of the Finance Committee, and I can tell you as a member of that Committee that tax expenditures have not received the attention that they deserve.

Here is how well-known conservative economist Martin Feldstein described tax expenditures in a recent oped in the Wall Street Journal. He said, and I quote: "Cutting tax expenditures is really the best way to reduce government spending." Let me repeat that: "Cutting tax expenditures," according to Martin Feldstein, "is really the best way to reduce government spending. . . . [E]liminating tax expenditures does not increase marginal tax rates or reduce the reward for saving, investment or risk-taking. It would also increase overall economic efficiency by removing incentives that distort private spending decisions. And eliminating or consolidating the large number of overlapping tax-based subsidies would also greatly simplify tax filing. In short, cutting tax expenditures is not at all like other ways of raising revenue." That is from an economic perspective and from a conservative economist.

As we consider ways to reform the tax code, it is important to keep in mind who is benefitting from the status quo. In recent years, the effective tax rate for the wealthiest in this country -- the rate actually paid after factoring in exclusions, deductions, credits, and other preferential treatment -- has fallen dramatically. In fact, the effective tax rate for the 400 wealthiest taxpayers fell from almost 30 percent in 1995 to 16.6 percent in 2007.

This trend was highlighted in a recent article in Tax Notes by tax expert Martin Sullivan. The article uses IRS data to compare the average effective tax rates for the residents of one Park Avenue building in New York City, where the average income is more than $1.1 million. And they compared that to the average effective tax rate for a typical New York City janitor, someone who might work in that very building, with an average income of $33,000. The data show that the average effective tax rate for the building residents was 14.7 percent -- those are the people with an average income of $1.1 million, while the rate for the janitor was 24.9 percent. His income, $33,000. I don't know how anybody can defend or justify that kind of tax burden. It's not right.

The reason for this disparity, of course, is that almost all of the janitor's income comes from wages, which are taxed at the regular income and payroll tax rates. The Park Avenue building residents, however, receive almost two-thirds of their income from investments, which are taxed at lower capital gains and dividends rates. In addition, the Park Avenue building residents receive a greater benefit from tax breaks because they itemize their deductions.

Tax expenditures are clearly worsening the disparity between how the wealthy are taxed compared to everyone else. If we look at the increase in after-tax income from tax expenditures, we can see that the top one percent received more than $142,000 from tax expenditures in 2009. The middle quintile received less than $2,800.

The President's Fiscal Commission included the kind of tax reform I believe will be needed. It demonstrated that by eliminating or scaling back tax expenditures, we can simplify the tax code, actually lower rates, and still raise more revenue. Here are the key elements of tax reform that were included in the Commission's plan:

  • It eliminates or scales back tax expenditures, and lowers tax rates.

  • It promotes economic growth and improves America's competitive position.

  • It makes the tax code more progressive.

  • Under the Commission's "illustrative" tax reform plan, instead of six tax brackets, there are three: 12 percent, 22, and 28 percent. The corporate rate would be reduced from 35 to 28 percent. Capital gains and dividends would be taxed as ordinary income. That would raise the effective tax rate of those people in the Park Avenue building, because they are paying an effective tax rate of 16 percent. They would go up to 28 percent. The mortgage interest and charitable deductions would be reformed, better targeting their benefits. The Child Tax Credit and EITC would be preserved to help working families. And the alternative minimum tax would be repealed.

  • The Commission's plan also increases revenue to 21 percent of GDP by 2022.

 

We simply will not be able to solve our nation's long-term fiscal and economic problems without fundamental tax reform -- tax reform that improves our economic efficiency, while also bringing in more revenue. And addressing tax expenditures has to be at the heart of that tax reform.
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