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POLITICAL CONNECTIONS

A Path to Reform

The way to achieve tax reform isn’t to take on tax expenditures one by one. It’s to cap their total value.

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Billionaire investor Warren Buffett listens to an address by President Barack Obama's last month in Washington, D.C.

CORRECTION: The print version of this column gave an incorrect number for how much revenue President Obama's Buffett Rule approach would raise--it would bring in about $520 billion over the next decade. 

The Buffett Rule is dead. Long live the Buffett Rule.

 

A Senate Republican filibuster this week killed the so-called Buffett Rule, President Obama’s proposal that millionaires pay at least 30 percent in federal income taxes. It died derided by its critics as class warfare and mourned only modestly by its supporters, many of whom applauded the principle but considered it something of a sideshow because it would have raised relatively small sums.

Yet if Congress reforms the tax code next year, it will likely take inspiration from one of the proposal’s core insights. The Buffett Rule looked to streamline the code not by repealing individual tax breaks but by making all of those loopholes less valuable to affluent taxpayers. Rather than reducing the supply of special tax breaks, the Buffett Rule would reduce the demand for them. If the next Congress and president are to succeed at lowering rates and raising revenues by simplifying the code, they will likely need to follow that strategy as well.

In both parties, broad interest now exists in flattening the tax code. Special exclusions, credits, and deductions reduce federal revenue by about $1 trillion annually, with that sum expected to rise to $1.5 trillion by 2016.

 

Some economists dislike tax expenditures because they distort decision-making (for instance, by encouraging people to spend too much on housing). Others oppose them because their benefits skew heavily toward the wealthy. Taxpayers in the 15 percent bracket save 15 cents on each dollar they can deduct in, say, mortgage interest; those in the top bracket save 35 cents. Few outside the top fifth of highest-earning families even file returns with itemized deductions that allow them to benefit from most of these breaks.

The result is that two-thirds of the benefits from all tax expenditures in 2011 flowed to the top fifth of earners, according to the Tax Policy Center; the top 1 percent alone (with incomes above $533,000) collected nearly one-fourth of all savings. That’s an average of nearly $220,000 each. By contrast, the group calculated, these breaks reduce taxes by only about $2,000 on average for families in the bottom 60 percent of earners. “It is completely upside down,” says Leonard Burman, a Syracuse University professor of public administration. “If you are in the 10 or 15 percent bracket, you’re not getting much of a subsidy. But if you are in the 35 percent bracket you’re getting a really big subsidy.”

If Washington spent less on those tax expenditures, it could reduce income-tax rates and also generate significant revenue for deficit reduction. With only slight variations, a succession of bipartisan commissions and initiatives, from the Simpson-Bowles and Domenici-Rivlin deficit-reduction panels to the Senate “Gang of Six” have embraced that approach.

Even the private budget negotiations last summer between President Obama and House Speaker John Boehner explored this concept. No matter which party controls the White House or Congress next year, it’s likely that Washington will pursue tax simplification (although Republicans might seek to use all of the resulting revenue to cut rates rather than to also reduce the deficit, as Democrats would demand).

 

The question is how best to advance that cause. Traditionally, most reformers have focused on retrenching or eliminating individual deductions. (Mitt Romney hinted at that approach in his overheard fundraiser speech last weekend.) But that kind of house-to-house legislative combat is very difficult because powerful constituencies like home builders protect all of the major tax breaks. Among the most expensive are the breaks for employer-provided health care and pensions; the mortgage-interest deduction; and deductions for state and local taxes and charitable donations.

Head-on assaults against any of those would probably end like Gallipoli. “Going deduction by deduction is a path to insanity,” says Steve Bell, senior economic adviser at the Bipartisan Policy Center and who was a Republican staff director for the Senate Budget Committee. “It won’t work.”

The alternative is the Buffett Rule approach: capping the total value of the deductions for taxpayers earning above some specified level. Separate from his Buffett plan, Obama has proposed to limit the value of most tax breaks to 28 percent. That would clip taxpayers in only the top two tax brackets and raise about $520 billion over the next decade. The Congressional Budget Office calculates that limiting the value of tax breaks to 15 percent would raise $1.2 trillion over that period (while affecting a broader pool of about one in four taxpayers). Martin Feldstein, the chairman of the Council of Economic Advisers in the Reagan administration, has coauthored a plan that would raise much more by capping the total value of deductions as a share of income for all tax filers.

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This demand-side approach wouldn’t eliminate political opposition to simplification. But it could make reform more likely by shifting the debate from the merits of each tax break to their cumulative impact. That insight deserves to live on, even as the Buffett Rule recedes.

This article appears in the April 21, 2012 edition of National Journal Magazine.

Don't Miss Today's Top Stories

Chock full of usable information on today's issues."

Michael, Executive Director

Concise coverage of everything I wish I had hours to read about."

Chuck, Graduate Student

The day's action in one quick read."

Stacy, Director of Communications

Great way to keep up with Washington"

Ray, Professor of Economics

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