WASHINGTON — A Congressional Research Service analysis suggests there are impediments to broadening the tax base by eliminating or reducing tax expenditures — such as tax-exemption for municipal bond interest — because they are viewed as “serving an important purpose” and are “quite popular” with the public.
The 41-page report published last week detailed some of the costliest tax expenditures in the tax code, including tax-exempt tax-credit bonds, which rank 11 in the top 20 largest individual tax expenditures for fiscal 2014. Tax-exempt tax-credit bonds would amount to $42.7 billion for fiscal 2014, 3.6% of all tax expenditures.
There are over 200 separate tax expenditures in the tax code that are projected to total over $1.1 trillion in fiscal 2014, but that revenue loss is highly concentrated. The largest 20 tax expenditures account for as much as 90% of the revenue loss from all tax expenditures and benefit millions of Americans, the report said.
“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,” CRS analysts Jane Gravelle and Thomas Hungerford said in the report.
While tax expenditures may be tough to cut, the authors said two issues arise when considering the preservation of tax-exempt bonds. The first is that the tax-exemption of interest “is more costly than a direct subsidy to the states since taxpayers at the highest marginal tax rate get a windfall.”
They point to the Build America Bonds program, which was established under the American Recovery and Reinvestment Act of 2009 and expired at the end of 2010. BABs are taxable but the Treasury Department makes subsidy payments to issuers at rates equal to 35% of their interest costs.
“Any change in tax-exempt bonds would presumably apply only to new issues of bonds and a shift to direct subsidies would not raise much revenue in the short run,” Gravelle and Hungerford said. Under this scenario, the Joint Committee on Taxation estimates it would result in a gain of about $3 billion for fiscal 2013 and would rise to $29 billion by fiscal 2021.
The second issue for tax-exempt bonds is that “about one-fifth of the cost of the exemption is not for general obligation bonds but for private-activity bonds.” Gravelle and Hungerford said these funds are borrowed by businesses and often allow interest to be excluded for private borrowing.
The authors concluded that any modification to tax-exempt interest would “likely need to be coordinated with corporate tax reform since corporations also purchase these bonds and, at least currently, are taxed at the top individual rate.”
The report suggests an alternative to eliminating the tax deduction would be to cap it, “perhaps as a percentage of income.” This change would apply to all taxes, not just income taxes.
The JCT found that limiting the deduction for all state and local taxes to 2% of adjusted gross income would raise an estimated $66 billion in fiscal 2014 compared to $89 billion if the deduction were eliminated altogether.
President Obama roiled the muni market in February when he proposed a 28% cap on the value of tax-exempt interest and other tax preferences in his fiscal 2013 budget. The cap would apply to single taxpayers with incomes over $200,000 and to married taxpayers filing a joint return with incomes over $250,000. It would take effect for taxable years beginning after Dec. 31, 2012.
The CRS analysis comes after House Budget Committee chairman Rep. Paul Ryan, R-Wis., released his controversial GOP 2013 budget proposal last week, which called for lowering the top income tax rate to 25% from 35%. Ryan and House Ways and Means Committee chairman Dave Camp, R-Mich., who helped draft the proposal, have insisted that lowering tax rates and closing loopholes should be the basis for comprehensive tax reform.
Republicans disregarded the CRS report. “Reports suggesting that tax reform isn’t easy are greatly appreciated but not really groundbreaking news,” said Michelle Dimarob, a Ways and Means Committee spokeswoman. “At this rate, tomorrow there will probably be a report saying the Earth is round or that water is wet.”
The committee’s top Democrat, Rep. Sander Levin of Michigan, said the CRS report highlights the importance of key tax provisions that Republicans would cut or eliminate and demonstrates the “implications of scaling back certain tax expenditures before blindly pinpointing a top tax rate.”