Tax Overhaul, Done Right, Could Prod Growth

Liz | 07/20 at 10:54 AM

 

Everyone, suddenly, is advocating tax reform, and with good reason. Having a war chest of more than one trillion dollars is what the government has at its disposal under the heading of “tax expenditures,” known to most of us as loopholes and deductions.

As Congressional leaders and President Obama scurry towards the finish line on our debt ceiling debate,  revising our tax system – and specifically the monumental tax breaks handed out to individuals and businesses – is front and center. The question is, will our leaders make the most of this moment, and set intelligent pro-growth priorities or will they succumb to narrow interests and pet projects? We can only hope, given 71,684 pages of unreadable prose known as the tax code.

One example:  When young people are urged to consider the tax ramifications of various wedding dates, you know it’s time to overhaul the system. That advice actually was one of the “Tax Savings for Young People” highlighted in a recent Kiplinger report, along with keeping close track of what it costs to move to a new job (but only if it’s “at least 50 miles farther from your old home than your old job was”), and encouraging parents to pay off student loans, since nowadays their children will get the interest tax deduction, “as long as the parents can’t claim him or her as a dependent, even if he or she doesn’t itemize.”

Who can sift through this nonsense? That was the conclusion reached by the Simpson Bowles fiscal commission, which described our individual tax system as “hopelessly confusing and complicated” and cited as well some 75 tax loopholes that muddy our business tax regime. The bipartisan panel recommended a widespread tax reform proposal that has caught fire as Democrats (and some Republicans) seek ways of increasing the government’s share of the nation’s income, without dreaded tax increases. 

The goal is called “decreased tax expenditures,” in Beltway lingua franca – but really it is dumping deductions and credits so as to reap higher revenues. The hope is that people (and companies) will be so elated to actually understand their tax returns – and to avoid the yearly 7.6 billion hours spent on tax compliance noted by Senator Tom Coburn (R-OK) in a new report—that they won’t mind “paying a little more” as President Obama frequently describes it.

Higher revenues, however, should not be the only ambition of those responsible for restructuring our tax system. As the Simpson Bowles group pointed out, the United States has not performed a sweeping review of its tax code in twenty five years.  (Even for Congress that seems a tad lax.) The country’s needs have changed over that period; what we require now is job creation. The commission estimated that currently our tax “earmarks” amount to $1.1 trillion per year – a juicy potential offset to our $1.5 trillion deficit, and a big tool to spur growth. 

Of course, not all existing deductions should disappear. The deduction for charitable giving, for instance, makes sense. Not only does it encourage donations to worthy causes, it also appeals to those of us who think that private organizations typically are better managed than those overseen by the government. 

What are our other priorities? The commission suggests we should promote “work, homes, health, charity and savings.” What about advancing entrepreneurship or manufacturing in the U.S.? We could allow more expansive write-offs for new business start-up costs and broaden deductions for healthcare costs, for instance. Some efforts like these have been enacted recently, but more could be done. The Tax Policy Center reports that “there has been a rise in social tax expenditures and a decline in business tax expenditures” in recent decades, due to the Tax Reform Act of 1986. That could be one reason that companies have increasingly outsourced overseas, or that the economy is slowing.  

It is the decades-long accumulation of tax tricks summoned up by narrow interests that so befuddles those trying to manage a small business or prepare their personal income taxes. While it is fun to read about the businessman who deducted his $100,000 swimming pool because it “made him relax so he could earn more money,”  it is maddening to consider that U.S. companies can deduct the cost of conferences held in Jamaica, but not in Zurich. Or that Eskimo whaling captains can take up to $10,000 annually in deductions, even though whale hunting is illegal for most of the country. Truly, it seems like a good idea to start over – eliminate all deductions and build from scratch.

One industry that in particular has accumulated tax benefits like barnacles on a hull is real estate. According to the Tax Policy Center, three of the ten largest tax expenditures encourage home ownership – mortgage interest deduction, exemption of capital gains taxes for home sellers and deductions for property taxes. In sum, these three items in 2008 amounted to almost $150 billion (out of a total in that year of nearly $900 billion) and amounted to more than the entire budget of the Department of Housing and Urban Development.

Add to that a slew of deductions available to landlords – for interest costs, property taxes, monthly condo fees, insurance, travel expenses and property management fees—and the tax breaks awarded property- oriented financial companies like REITs—and real estate emerges a big winner in the U.S. tax lottery. Oil and gas companies, by comparison, look deprived.

Favoritism shown the real estate industry has cost the country dearly, by funneling excessive investment into property. The message here: tax incentives do matter. Let us hope that in the next overhaul, our legislators get it right, and put us back on a path to growth. 

 

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