The voices of Tax Policy Center's researchers and staff
“We have met the enemy and he is us,” said the cartoonist Walt Kelly. He was talking about preserving the environment, but he could have been describing our national addiction to tax credits, deductions, and exclusions.
These tax breaks increase after-tax income for nearly all of us. At a panel discussion this afternoon, my Tax Policy Center colleague Eric Toder described how eliminating every tax preference would cut average after-tax incomes by more than 11 percent.
Keep these numbers in mind as Congress considers the many plans on the table aimed at cutting tax preferences and lowering tax rates. The most recent: The House Republican fiscal plan rolled out yesterday by Budget Committee Chairman Paul Ryan (R-WI). The Ryan plan would cut the top individual and corporate tax rates to 25 percent and offset the cost by curbing tax deductions, credits, and exclusions. The plan does not, however, identify which preferences would be cut or how. Btw, it would use none of the revenue from eliminating tax breaks to help reduce the deficit.
The TPC research also provides an important perspective on just who benefits the most from these tax breaks. Remember the debate a year ago about how nearly half of American households pay no income tax? At the time, much of the focus was on how refundable credits for low-income families, such as the earned income and child credits, wipe out the income tax bills of many. And while that is true, it turns out that the biggest beneficiaries of tax preferences are not the lowest earners, but the highest. These deductions don’t wipe out the tax bills of the rich, but they cut them—a lot.
The TPC analysis finds that the top 0.1 percent, those making an average of $9.5 million-a-year, would see their after-tax incomes fall by an average of $1.5 million, or almost 23 percent, if all individual tax breaks were eliminated. By contrast, the lowest 20 percent of earners, those making an average of only about $12,000, would see their incomes fall by only about 9 percent.
Interestingly, different income groups are helped by very different preferences. For example, those at the top of the economic food chain benefit from low tax rates on capital gains and dividends, as well as the exemption for gains on assets transferred at death. Low-earners are helped most by those refundable credits, such as the earned income and child credits. And upper-middle class taxpayers take advantage of breaks such as the mortgage interest deduction and subsidies for retirement and employer-sponsored health insurance.
It goes without saying that the widespread use of these tax preferences will make it especially hard for Congress to get rid of them. But even if it tried, avoiding major short-term pain would require Congress to slowly phase out these tax breaks, said another panelist, John Buckley, the former chief Democratic tax counsel on the House Ways & Means Committee. Buckley, now a law professor at Georgetown University, warned that dumping these tax breaks will probably generate far less revenue than proponents hope, both because of a slow transition and because high-income taxpayers will find other ways to shelter income.
And that, in turn, may have some important implications if lawmakers try to pay for cuts in tax rates by broadening the base.
As usual, a couple of caveats to the TPC paper. It excluded those tax breaks for businesses that report their income on individual returns, so left out preferences such as accelerated depreciation. It assumed people would not change behavior in response to the elimination of tax preferences, which they almost certainly would. Also, while it compared the changes to both current law (assuming all the 2001 and 2003 tax cuts expire), and current policy (assuming today’s tax law remains in place), all the numbers I used in this post were based on the taxes we are paying today.
However you look at it, however, Walt Kelly was right. And if we really want to lower tax rates and cut the budget deficit, we are all going to have to give up some of our most cherished benefits.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.