The Congressional Research Service (CRS) has released a new report by Jane Gravelle and Thomas Hungerford called “The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base Broadening.” In a nutshell, the report could be called “Base Broadening Is Hard to Do.”
The Washington Post’s Lori Montgomery summarized it nicely on Friday, including this Republican staffer’s sarcastic reaction to the report:
“Reports suggesting tax reform isn’t easy are greatly appreciated. We look forward to future reports on water being wet,” said Sage Eastman, a senior aide to House Ways and Means Committee Chairman Dave Camp (R-Mich.), whose panel drafted the principles for tax reform laid out in the Ryan budget.
The CRS report emphasizes that although the 200-plus tax expenditures for individuals under the federal income tax are worth more than $1 trillion per year, the largest 20 of them represent 90 percent of that revenue loss to the government.
When you look closely at that “Top 20” list (copied below from the CRS report), it is easy to get discouraged about the prospects for substantial broadening of the tax base. As I explained last November in Tax Notes (subscription-only access here), the largest tax expenditures look a lot more like “entitlements” than “loopholes”:
Consider the biggest of the big tax expenditures: the exclusion for employer-provided healthcare and itemized deductions. Economically, there is little rationale for subsidizing those particular activities, especially for handing out the largest subsidies to people with the highest incomes. But politically they are untouchable. They clearly benefit real people, not just individuals or corporations of questionable reputation, and they are far from “loopholes” that are easy to cut.
Those individual income tax expenditures sound a lot like entitlement spending, defined by Merriam-Webster’s Dictionary of Law as “a government program that provides benefits to members of a group that has a statutory entitlement.” Those groups are employees with health insurance, households with mortgages, people who donate to charities, and so on.
The CRS analysis acknowledges the political popularity of those largest tax subsidies and also calls attention to the administrative challenges in taxing previously untaxed income -- particularly regarding healthcare benefits. For those reasons the CRS authors conclude: “It appears unlikely that a significant fraction of this potential revenue could be realized.” More than $1 trillion that could be gained if all tax expenditures were eliminated, enough to support substantial reductions in marginal tax rates -- including cutting the top rate from 39.6 percent down to 23 percent. The study’s authors, however, believe “it may prove difficult to gain more than $100 billion to $150 billion [per year] in additional tax revenues through base broadening.” Note that this implies that only about 1/10th of the total value of tax expenditures would be cut.
I think we could actually do better. For example, in his latest budget the President has proposed scaling back a lot of the benefits of these largest tax expenditures for the richest households to the levels of benefits that would be obtained at lower marginal tax rate brackets. That would be an ambitious amount of base-broadening, although only for a very narrow group of taxpayers -- those with household incomes above $250,000. That narrowness limits the revenue gain to $584 billion over ten years–which is like broadening the tax base by about 1/20th the total value of tax expenditures, but if the strategy were expanded to income taxpayers more broadly and the maximum subsidy rate correspondingly reduced, the revenue potential would be much larger.
As that example illustrates, there are ways to substantially reduce the cost of the most expensive tax expenditures to make the reductions more palatable from a distributional perspective while still raising enough revenue to support a decent amount of rate reduction.
CRS Table of 20 Largest Individual Income Tax Expenditures: