In light of Sen. Patty Murray’s plan to raise (at least) $975 billion in tax revenue over the next ten years by closing corporate and individual tax loopholes, one has to wonder: which tax loopholes does she have in mind?
Last April, Donald Marron of the Tax Policy Center (TPC) assessed the impact of tax expenditures on federal tax revenue:
For fiscal 2012, for example, individual income tax expenditures total $942 billion and corporate ones $151 billion. On a static basis, those provisions thus reduce income tax receipts by almost $1.1 trillion. In addition, some provisions — the refundable credits— also increase federal outlays. Those outlay effects total another $91 billion in fiscal 2012, primarily from the earned income tax credit and the child credit. The total budget impact of income tax expenditures in 2012 is thus nearly $1.2 trillion.
Marron’s 2012 calculation doesn’t directly apply to the coming years, as the higher rates in the post-cliff tax code imply that the value of income tax expenditures will be somewhat higher than they had been pre-cliff, though not dramatically so. By way of comparison, TPC assumed that the value of tax expenditures in 2015 under the pre-cliff code would have been $1.305T against $1.366 under what had been current law code — so the number under the post-cliff code would likely be somewhat in-between.
Given that Murray presumably wants to keep refundable tax credits in place, $1.1T or $1.2T is a good starting point: roughly speaking, Murray intends to shave total tax expenditures by a little less than a tenth.
Tom Curry of NBC News quotes Murray as follows:
The plan, offered by Senate Budget Committee Chairman Patty Murray, D-Wash., would seek $975 billion in spending reductions over the next 10 years as well as $975 billion in new tax revenue, which she said would be raised by “closing loopholes and cutting unfair spending in the tax code for those who need it the least,” according to Murray’s prepared remarks opening her committee’s consideration of the plan. [Emphasis added]
Murray’s task is much easier than that facing supporters of the Romney-Ryan tax reform. Whereas Romney-Ryan lowered rates, Murray presumably intends to stick with the post-cliff statutory tax rates. And so the value of income tax expenditures will be higher for high-earners, thus giving her more room to reduce income tax expenditures for high-earners.
One complication is that the post-cliff code included, per John McKinnon of the Wall Street Journal, “provisions that reduce the value of personal exemptions as well as most itemized deductions.”
The PEP and Pease limits work on the same basic principle, limiting the value of exemptions and deductions for households that exceed a threshold. For example, the Pease limitation reduces a household’s itemized deductions by 3% of the amount over the threshold. The reduction can’t exceed 80% of the total deductions.
A couple with income of $400,000 average about $50,000 in itemized deductions, according to IRS statistics. Because their income would exceed the $300,000 threshold by $100,000, their allowed deductions would be reduced by about $3,000 to $47,000—potentially boosting their tax bill by about $1,000.
The original proponent of the deduction limit, the late Rep. Donald Pease of Ohio, viewed it as “the best available means…to ensure that nobody could game the system,” given the growing number of tax breaks that were being passed by Congress, said William Goold, his former chief of staff. The limit might be viewed now as dated, but “the goal remains as valid now as it did then,” he added.
From a political standpoint, the limits allow the Obama administration to achieve its long-sought goal of raising taxes on people making more than $250,000. PEP and Pease represent about $150 billion of the tax increase of about $620 billion over 10 years, making them a key element of the deal. [Emphasis added]
The Pease limitation already reduces itemized deductions for high-earners. Murray’s proposal would require going further.
One model for how Murray might proceed is a 2011 proposal from Martin Feldstein, Daniel Feenberg and Maya MacGuineas that caps individual tax expenditure benefits to 2 percent of adjusted gross income (AGI).
Recently, Diane Lim of the Pew Charitable Trusts offered a number of policy options for capping individual tax expenditure benefits in a progressive manner. The likeliest candidates, in my view, are:
1. Limit marginal-tax-rate-dependent tax preferences to one of the lower-bracket rates. President Obama has proposed a limit of itemized deductions to the 28 percent rate in each of his past budgets; in 2012 he expanded the proposal to include some other tax expenditures such as the exclusion of employer-provided health benefits and the preferential tax rate on dividends. The Congressional Budget Office (CBO) estimated that this expanded version would raise $523 billion over ten years (CBO 2012). (The prior versions of the 28-percent limitation, which were limited to itemized The Hamilton Project • Brookings 3InnovatIve approaches to tax reformProposal 7: Limiting Individual Income Tax Expenditures Diane M. Limdeductions, were estimated to raise almost $300 billion over ten years.) The CBO has also described a proposal to further limit the rate on itemized deductions (but not other tax preferences) to 15 percent. The CBO estimates this proposal would raise $1.2 trillion over ten years (see CBO 2011, revenue option 7, pp. 151–152).
4. Cap the total dollar value of itemized deductions without regard to income level. This is a popular option that was discussed in negotiations about the fiscal cliff in December. The TPC has estimated the effects of $17,000, $25,000, and $50,000 caps (which would raise $1.6 trillion, $1.2 trillion, and $727 billion, respectively) over ten years relative to the (old) current-law baseline (with all of the 2001–2003 tax cuts expired).
And the fact that Mitt Romney and a number of congressional Republicans floated related ideas might prove politically advantageous. Some number between $25,000 and $50,000 would hit Murray’s revenue target.
A better but more controversial way to go would be:
2. Convert marginal-tax-rate-dependent tax preferences to nonrefundable tax credits. This is similar to option 1 except it would benefit non-itemizers as well, and everyone would receive the same subsidy rate regardless of one’s marginal tax rate bracket. The Tax Policy Center (TPC) has estimated the effects of a 15 percent credit to replace not just itemized deductions, but also the exclusion of employer-provided health insurance and the preferential tax rate on capital gains and dividends. The TPC estimates the option would raise more than $2.7 trillion over ten years (Baneman et al. 2012).
I’m interested in base-broadening measures of this kind not to increase revenue levels beyond the post-cliff code, but rather because I’m interested in identifying ways to finance a greatly expanded child credit. This would be a highly effective way to counter Murray’s political message: she wants to limit tax expenditures for high-earners to finance spending growth. We want to limit tax expenditures for high-earners to give working families with children substantial tax relief.
Think about how this contrast would play with Gerald Seib’s Gang of Thirteen:
To define this group, start with the six Democratic senators running for re-election next year from states carried by Republican presidential nominee Mitt Romney: Mark Begich of Alaska, Max Baucus of Montana, Kay Hagan of North Carolina, Tim Johnson of South Dakota, Mary Landrieu of Louisiana and Mark Pryor of Arkansas.
Add to the list two senators from swing states also running in 2014, Mark Warner of Virginia and Mark Udall of Colorado.
All face voters next year in states where voters either lean red or have limited regard for party labels. All have reason to show they can find middle ground.
Throw in West Virginia’s Joe Manchin, Missouri’s Claire McCaskill, Indiana’s Joe Donnelly, North Dakota’s Heidi Heitkamp and Montana’s Jon Tester, who were elected from red state states last year, and you have 13 Democrats who have either the potential or the need—or both—to break the fever that grips the political system.
I doubt that you’d win over all of these Senate Democrats to the cause of swapping tax expenditures for high-earners for an expanded child credit — but might Republican Senate candidates in Alaska, Montana, North Carolina, South Dakota, Louisiana, and Arkansas be able to make some noise by contrasting Patty Murray’s vision of increased government spending vs. giving working parents a break?