The D.C. Dodge: Tax Reform You Buy Now, Pay For Later - Or Never

Beware pols who claim they'll close tax loopholes, but don't say which ones

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A stack of standard 1040 individual income tax forms.
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I call it the D.C. Dodge.  To understand what it is, you need to grasp two things. 

The first is so-called "tax expenditures." Each year, the U.S. Treasury foregoes over $1 trillion in revenues through credits, deductions and loopholes for favored activities.  Some are widely accepted; you yourself may be benefitting from one or more, like the ability to subtract mortgage interest payments from your tax bill, or the tax credit your employer claims for the cost of the health care you get through your job. Others are less popular (except with their beneficiaries, of course), like the "carried-interest deduction," which gives hedge fund managers get a fat tax break on the bulk of their pay.

Tax expenditures are basically government spending programs by another name.  And we’re not talking about chump change here.  The mortgage interest deduction costs $100 billion a year, and the employer health exclusion, $164 billion. (The carried-interest loophole costs $2 billion a year).  That’s about a fifth of the current budget deficit.

The second thing you need to know about the D.C. Dodge is that almost every version of tax reform invokes it.  When you hear someone say, "Lower the rates, broaden the base," they may well be doing the dodge.

That is, they're claiming they're going to cut tax rates and make up for the lost revenue by doing away with tax expenditures to create a broader, i.e., more inclusive, tax base.  There’s nothing wrong with that.  In fact, it formed the basis of the 1986 tax reform, widely viewed as a successful, albeit temporary, improvement of the tax code.

What makes someone a dodger is when they fail to say which tax expenditures they plan to eliminate in order to pay for their rate cuts.  Someone who says, "If America’s homeowners are willing to start paying taxes on their mortgage interest payments, I can lower the tax rate by a point!” is decidedly not doing the dodge. Much more common, however, is the politician who claims his/her rate cuts can be paid for with … well, never mind that for now. When the base broadeners are left unspecified then you’re in the company of a D.C. Dodger.

The most recent example of this is the House Republicans' budget authored by Rep Paul Ryan, whose dodge was so egregious that he may have finally convinced people he’s not the fiscal hawk he’d like you to think he is (more like a chicken hawk).  His budget lowers the top tax rate for both income and corporate taxes from its current 35 percent to 25 percent.  The income tax cut alone adds over $4 trillion to the deficit over ten years, and comes on top of the $8-9 trillion cost of permanently extending the Bush tax cuts, which Ryan wants to do. 

But not to worry.  It’s all to be paid for later by closing unspecified tax loopholes.

Ryan is only the most recent D.C. Dodger.  The Bowles-Simpson deficit-cutting plan, beloved by all, does a bit of the dodge, though to the credit of its authors, former Clinton chief of staff Erskine Bowles and retired GOP Sen. Alan Simpson, they provide an illustrative proposal that ends the tax break for dividends and capital gains and reduces the mortgage interest and employer health care deductions.  Similarly, although the president’s recent corporate tax reform plan mentioned a few big-ticket tax breaks that would need to be closed, it left a lot to the imagination.

Some of you who follow this sort of thing may think I’m being too critical in the following sense.  The best way to shut down tax reform is to evoke, right out of the gate, the ire of the lobbies behind the tax break you’re now explicitly going after. Better, it is said, to get people excited about lower rates; then, in the heat of negotiation, before the lobbyists can mobilize, policy makers will agree to the base broadeners.

I myself have played that game, helping to write budgets with magic asterisks.  But I no longer think it makes sense.

Simply put, my fear is that the D.C. Dodge will leave us with the lower rates but without the broader base.  People like the big-ticket expenditures – more than 90 percent of respondents to a recent poll thought the mortgage interest deduction was "very" or "somewhat" important – and Congress just isn’t up to making the case that you can't have both lower rates and all the expenditures you want.  Moreover, just mention a tax increase these days, and the 98 percent of House Republicans who signed Grover Norquist's no-tax-pledge will be running attack adds in nanoseconds.

This doesn’t mean I’m against reform.  It’s the dodge I’m against, and I encourage you to be as well.  Someone wants to pay for a rate cut by closing a loophole?  Be our guest.  But make the loophole explicit, fight to get it closed, and, most importantly, write the legislation in such a way that you don’t get one without the other.

But to be perfectly frank, I think a lot of this tax reform stuff is overblown.  There’s much that’s wrong with the code and we should clear out a lot of brush.  I’d close the carried interest loophole tomorrow and shut down overseas deferral today (that’s where multinationals can defer taxation on foreign profits by just holding the profits outside of the country—it’s a tax incentive to outsource and offshore).

The problem I have with this debate is that it creates the impression that a big house cleaning of the tax code is the best way to fix America, and I don't buy it, for a couple of reasons. First, it's not going to happen any time soon, given a polarized Congress comprising too many members who have pledged to block any increase in revenue. Second, there's a simpler way, and that's to revert -- slowly, as the economy approves -- to the tax rates of the Clinton years, a time of budget surplus and strong, broadly shared economic growth. All we have to do is let the high-end Bush tax cuts expire on schedule at the end of this year, and phase out the rest over time.

By all means, close the most offensive loopholes (the ones just noted).  As for a massive overhaul, I don't see how we get there from here.  What I see instead is a bunch of D.C. dodging.

You can email me at info@jaredbernsteinblog.com. I look forward to your feedback.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities. From 2009 to 2011, he was the Chief Economist and Economic Adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class, and a member of President Obama’s economic team.

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