Tax Reform and the Revenue Problem

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Perhaps the best hope for long-term deficit reduction currently on the table is a bipartisan plan being crafted in the Senate. It’s roughly based on the proposal presented by the President’s deficit commission last year and would include discretionary spending cuts, Medicare/Medicaid reform, changes to Social Security and an overhaul of the tax code. Of the four, tax reform comes closest to enjoying some semblance of bipartisan consensus and it has great potential to help the federal government back to black. But the obstacles to significant reform are ingrained in the culture of Washington.

In the age of austerity, spending is frowned upon. Politicians across the spectrum have fallen in love with little fiscal fortune cookie phrases like, “As families and businesses across the nation have tightened their belts, so must the federal government.” Obama used almost this exact canard when discussing his new budget proposal Monday in Maryland. Cutting is in vogue, but Americans still want things — government subsidized research, homes, jobs etc. — and politicians still want to provide them. While everyone is busy debating how to trim the fig-leaf that is non-defense discretionary spending, everybody is getting their goodies another way. Instead of “spending,” desirable projects are slipped into the tax code with deductions, credits and exemptions. When Republicans resist, the pot is simply sweetened with more cuts as it was last December. Each cause may or may not have its merits, but taken with the Bush tax cut extensions they really add up. Here’s NewsBeast’s (BeastWeek’s?) Andrew Romano on the Obama years so far:

…$238 billion in cuts for taxpayers and businesses came as part of the stimulus package. The second portion, $721 billion worth, arrived in December, again as part of Congress’ bipartisan tax compromise. Subtract $54 billion in forthcoming stimulus-related tax hikes, and you’ve got a grand total of $905 billion in tax cuts. In other words, Obama has slashed one tax dollar for every dollar he’s spent on government programs.

This trend isn’t unique to the last two years, and it has left us with a revenue problem. Effective tax rates are way down and the government doesn’t have enough money coming in to cover its bills. Part of the problem is simply recessionomics; tax receipts fall when the economy is under-performing. But the revenue problem is bigger than that. Need a good example? Look no further than Obama’s new budget plan. About a third of the money saved in the plan comes from taxes: ending the charitable donation and mortgage interest deductions for high earners, raising taxes on the oil and gas industry, among other tweaks. Here’s the problem: They’ve been included in Obama’s budget proposals before and never made it into law. If a Democratically controlled Congress didn’t get it done, why would a Republican House?

There’s also the matter of yet more tax expenditures in Obama’s budget. “There are new tax credits for investments in green energy and energy-efficient commercial buildings,” writes the Tax Policy Center’s Howard Gleckman. “There are $2.5 billion in new tax breaks for businesses in ‘designated growth zones.’ That’s on top of an additional $1.8 billion in ‘New Markets’ tax credits and $2 billion in special tax breaks for transit projects in New York City. And there’s more. He’d expand and make permanent the research and experimentation (usually called the R&D) tax credit, at a cost of $100 billion over 10 years.”

When people talk about “tax reform,” they’re usually talking about eliminating these kinds of credits and exemptions while lowering overall rates. President Obama has been especially bullish on corporate tax reform in recent weeks. “I’m asking Democrats and Republicans to simplify the system,” he said in his State of the Union address. “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years.”  “The whole concept of corporate tax reform is to simplify, eliminate loopholes, treat everybody fairly,” Obama repeated at a Tuesday press conference. Sounds great. But, as noted above, it’s not realistically reflected in his budget, and when you begin to examine what Obama calls “loopholes,” you run into some serious problems. Let’s start at the top with with the largest exemptions for corporations (costs listed are over five years):

The largest estimated loss ($169 billion) over five years comes from deferral of foreign source income of U.S. multinationals. In the past, the revenue gain from eliminating deferral has been estimated as much smaller than the ongoing revenue cost under current law. And the corporate leaders now advising the President are likely pushing him to move in the opposite direction, following our major trading partners, who exempt foreign-source income. The second largest, accelerated depreciation of machinery and equipment, costs an estimated $147 billion. But this tax expenditure, which broadly subsidizes domestic investment for a wide range of business firms, has just been increased, with the support of the Administration, by allowing full expensing for investments made in 2011. The President has endorsed making the research credit permanent (scored at $13 billion over 5 years last year, but since increased because Congress extended it) and no one would even consider eliminating expensing of research and experimentation activities ($32 billion over 5 years).

To give you a sense of scale: The Senate’s plan is said to net $180 billion in new revenue over ten years. That’s barely more than what the single largest corporate tax exemption costs the government in half that time. These aren’t “loopholes.” They’re how we do business.

A telling example: General Electric, whose CEO Jeffrey Immelt recently landed a high-profile role heading up Obama’s advisory “Council on Jobs and Competitiveness,” pays some of the the lowest taxes of any corporation in America. The marginal corporate tax rate may be 35%, but GE effectively paid 15% in 2007, just 5.3% in 2008 and not one single penny in 2009. After recording $10.3 billion in income, they actually got a $1.1 billion tax benefit from the government. If that’s not a revenue problem, what is?

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