A Tax Policy Center report shows how difficult it would be to cut tax preferences, such as tax-exemption, to pay for lower rates. The report comes as President Obama, lawmakers and deficit reduction groups have proposed curtailing tax-exemption and other tax preferences as part of comprehensive tax reform.
In a related matter, Sens. Orrin Hatch, R-Utah, and Mitch McConnell, R-Ky., earlier this week offered an amendment to a jobs bill that would require the Senate Finance Committee to vote within 12 months for tax reform legislation that includes permanent repeal of the alternative minimum tax and cuts in tax preferences and individual tax rates.
Hatch wants an amendment added to the Small Business Jobs and Tax Relief Act, which is to be voted on this week by the Senate.
“Tax reform isn’t written in the amendment but serves as a guideline for the committee,” a spokesperson for McConnell said.
Antonia Ferrier, a spokesperson for Hatch, said the Senate Finance Committee would have discretion over which preferences would be eliminated. The amendment would also extend the Bush tax cuts for people of all incomes for one year. Obama had proposed extending the Bush tax cuts by one year, but only for families making $250,000 or less.
The 20-page TPC report said that while it may be tempting to conclude, based on information from the Treasury Department, that tax expenditures would total more than $1.4 trillion in 2015, that amount would “significantly overstate the actual potential for tax reforms to achieve lower rates through base broadening, for four key reasons.”
First, lower rates would reduce the value of most tax preferences. Muni analysts have pointed out that the value of tax-exempt bonds decreases with lower tax rates. Second, many tax preferences would be hard to curtail for political or administrative reasons. Third, cutting back on tax preferences may alter the distribution of the tax burden in ways that are deemed unacceptable to lawmakers or voters, the report said. Finally, the wholesale, immediate repeal of many tax preferences would “significantly disrupt existing economic arrangements in ways that might be deemed unfair,” it said.
The four authors — Hang Nguyen, James Nunns, Eric Toder and Roberton Williams — said, “Paying for lower rates would require substantial reductions in broadly used and popular preferences.” and “requiring that changes maintain the current progressivity of the federal income tax would make it much harder to find a politically acceptable mix of preferences to curtail.”
The report shows the impact on income tax revenues and distribution of tax burdens from cutting tax preferences and tax rates under three scenarios. They are: current tax law, under which the top rate on ordinary income would be 39.6% and the rate on capital gains would be 20%; current policy, with a top rate of 35% on ordinary income, a 15% rate on capital gains and qualified dividends, and indexing AMT for inflation; and current policy, with a top rate of 28% on ordinary income, a 15% rate on capital gains and dividends retained, and repeal of the AMT.
The authors divide up the 173 tax expenditures into four groups and put the exclusion of interest on tax-exempt bonds in the second-least politically and administratively feasible of the groups. This group also includes Build America Bonds, some tax-credit bonds, special rates for capital gains, and deductions and exclusions of contributions to retirement accounts.
The revenue loss from this second group of tax expenditures in 2015 would be $439 billion under current law, $429 billion under current policy and $327 billion under a current policy with reduced rates scenario, according to the authors.
That compares with an estimated revenue loss for the first group of tax expenditures, which includes itemized deductions for home mortgage interest, charitable contributions and state and local taxes, of $590 billion under current law, $525 billion under current policy and $446 billion under current policy with reduced rates.