The Congressional Research Service recently released a report by Jane Gravelle and Tom Hungerford on The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base Broadening (Mar. 12, 2012). Tax Base Broadening is the proposal often put forward by those who say we can and should lower rates across the board (also reducing progressivity by limiting the number of rate brackets to two or three) and pay for it by removing some of the tax expenditures and subsidies in the tax system, such as the home mortgage loan interest deduction or certain health benefit provisions.
IHere's an excerpt from the summary of the report.
Congressional interest in a major reform of the individual income tax that would broaden the base and use the additional tax revenues to lower rates and/or reduce the deficit has increased. ... One way to broaden the tax base is to eliminate or reduce tax expenditures, which have been in the tax code since the passage of the progressive income tax in 1913. An understanding of four complex issues surrounding tax expenditures is necessary for an informed debate over broadening the tax base. First, tax expenditures affect the economic behavior of taxpayers (efficiency effects). Second, changing tax expenditures will change the distribution of tax benefits, and the distribution of after-tax income (equity effects). Third, changes to tax expenditures could change
the administrative burdens on taxpayers and the Internal Revenue Service (IRS). Lastly, many tax expenditures are popular among taxpayers and voters. Each one of these issues presents challenges to broadening the tax base, which could be difficult to overcome.
There are over 200 separate tax expenditures, which are projected to total over $1.1 trillion in FY2014. The revenue loss of all tax expenditures, however, is highly concentrated in a relatively small number—the largest 20 tax expenditures account for 90% of the total revenue loss of all tax expenditures. This amount is equivalent to 74% of the total FY2014 revenue from individual income taxes....
[T]ax expenditures are divided into seven major categories: saving, business investment, consumption, owner-occupied housing (which is a combination of an investment choice and a consumption choice), labor supply, government programs (which in many cases would have no behavioral effects but are simply income transfers), and a category termed structural (which provides benefits based on family circumstances rather than affecting behavior).
The analysis in this report suggests there are impediments to base broadening by eliminating or reducing tax expenditures, because they are viewed as serving an important purpose, are important for distributional reasons, are technically difficult to change, or are broadly used by the public and quite popular. Given the barriers to eliminating or reducing most tax expenditures, it may prove difficult to gain more than $100 billion to $150 billion in additional tax revenues through base broadening. This amount could have a significant effect on reducing the FY2014 budget deficit—reducing the projected $345 billion deficit by 30% to 43%. This additional tax revenue, however, is equivalent to about 6% to 9% of projected FY2014 individual income tax revenue, and, consequently, would not allow for significant reductions in tax rates (about a one or
two percentage point reduction for each bracket).
The conclusion of the report seems realistic given the current dysfunctionality of Congress--it would be highly unlikely that core reforms could be made to raise sufficient revenues to support a large rate reduction, though some elimination of problematic tax expenditures would be a good move towards reducing our structural budget deficits. Let's eliminate the long-term subsidies for the extractive industries that have given subsidized profits for oil and gas barons and get rid of other provisions that haven't served the purpose claimed for them, like the research & experimentation credit (any business can deduct real research expenses; the credit is just a way to cut corporate taxes for heavily lobbying industries like Big Pharma, IT and others). But let's acknowledge that the current right-wing fad idea to reduce tax rates even more and pretend to pay for it with uny base broadening isn't going to work.
I find base broadening proposals for tax policy reform amiss for three other important reasons.
First, we already collect less tax as a percent of GDP than historically; thus,we need to raise more tax revenue rather than maintain revenue neutrality with the current too-low tax system, especially by increasing the take from corporate taxes (the 'tax shelter problem') and by reducing the ability of service partners to game the system (the 'carried interest' problem).
Second, most ideas for base broadening and rate lowering end up resulting in more rate lowering than base broadening, because the lobbyists get to work immediately on reinstating the provisions that have been eliminated to broaden the base while simultaneously arguing that letting the rates go back up would be a growth-killing tax increase. Accordingly, base broadening won't work unless there is a firm will to maintain a broader base and take the political flack that the lobbyists will release. This Congress isn't anywhere near having that kind of will, and if it does, it is more likely to reduce important social programs (Medicare, health care, education, etc.) and leave the notoriously inefficient subsidies for oil and gas, Big Pharma and other lobby-hard favorites in place.
Third, much of the assumptions about tax efficiency are questionable--we actually understand the interactive effects of the tax system very poorly, and don't know when a tax change will affect a person's decisions to work, not work, spend, not spend, or otherwise respond to the tax change. So it is more likely that ideology will drive the decisions, rather than an unbiased approach founded on reasonable research to determine which provisions really work to do what they were claimed to be enacted to accomplish. And given the current lopsided representation of right-wingers in Congress (compared to the population at large), that means that right-wing rhetoric rather than considered policy determinations will likely drive any "base broadening" tax reform that does take place.
Fourth, many of those who argue for base broadening may be planning to use this as one more way to reduce or eliminate spending on important safety net provisions like Medicare, Social Security, unemployment compensation and others.
So my preferred reform involves a few simple ideas: 1) let the Bush tax cuts expire as they are slated to do; 2) reinstate the estate tax at the 2001 rates, except with a $2 million exemption that is indexed to inflation; and 3) eliminate the preferential rate for capital gains and all of the provisions in the Code that deal with capital gains rates; and then 4) wait a while till the system is back in better balance and do tax the right way--ask what we want our government to spend money on, figure out how much money that will take to do it, and then set the tax system so that it collects the right amount of money.