Friday, September 02, 2011

Spending by Any Other Name: What's So Bad About Tax Expenditures?

-- Posted by Neil H. Buchanan

In late July, during the height of the debate over raising the debt limit, I argued that the crisis would give politicians' further incentive to replace direct spending with "tax expenditures" -- the ever-growing set of programs that puts money into the pockets of households and businesses by reducing their tax liabilities rather than formally sending them Treasury checks. While most of the commentary on tax expenditures is quite negative, decrying the excessive use of the strategy, I noted that -- "for reasons that I will surely write up as a blog post sooner or later" -- I am not convinced that the growing use of tax expenditures is a bad thing, Today, I return to that issue.

If you are lucky enough to have a job, and luckier still to have an employer who provides health insurance, you are the recipient of a tax expenditure. Why? Because the money that your employer spends on your health insurance is not taxed, even though that money is just as much "compensation" from your employer as is your regular salary. The government thus collects less money in taxes, and you and your employer share a subsidy that reduces the cost of your health insurance. This result could also be achieved by sending a Treasury check in your name to a health insurer, but it is politically expedient to adopt a strategy that looks like a "tax break" rather than a "spending increase."

This strategy has become so popular that the tax system now is the home to roughly one trillion dollars in spending-equivalent tax breaks. The tax code is peppered with subsidies for home ownership, for retirement saving, for higher education, for charitable giving, and on and on. While the trend is unmistakable, the question is why so many people deplore it.

As an initial matter, one must simply say that it seems dishonest! The entire strategy boils down to elevating form over substance for political reasons. It is understandable, therefore, that we might want politicians to stop lying and just call spending spending. Transparency is an important goal of good governance, and tax expenditures would seem to be the essence of obfuscation. Any time the government engages in rank double-talk, we run the risk of diminishing still further the public's ability to trust anything that they hear from their political leaders.

It is nice to imagine a world in which spending could be called spending. Word play is annoying, and dishonesty should not be rewarded. Still, given that everyone is already onto this game, what difference would it really make if we were to re-categorize every program according to its Platonic ideal? Indeed, maybe we are so far down this particular slope that we would be better off enjoying the ride the rest of the way down than trying to fight the law of gravity. If everything is finally called a tax benefit, after all, then the playing field would be level once again. Orwell might be somewhat peeved, but as long as everyone understands what the words mean and what is really going on, even he could have no serious objection.

A more substantive concern about the growing use of tax expenditures is that Congress arguably fails to review tax expenditures as carefully as it does regular spending programs. Gaining approval of a spending program involves navigating four committees (the committee with subject matter jurisdiction in each house, along with the appropriations committee in each house), whereas a "tax cut" requires approval from only two committees (Ways and Means in the House, and Finance in the Senate). It appears, therefore, at least to be procedurally easier to enact a tax cut than a spending increase.

This objection, however, elevates form over substance in its own way. It is not necessarily more difficult to navigate four committees than two, depending on the nature of the committees and their membership and rules. Ways and Means and Finance are both large committees with expert staffs, which suggests that they are not pushovers. In any case, there is not even a prima facie basis for saying that four committees are better than two. It could be that the process for spending programs is too burdensome, not that the process for tax cuts is too easy.

A related claim is that tax expenditures are not reviewed with the regularity and rigor applied to other spending programs. The legitimate concern is that tax expenditures could be the method by which the Leviathan ineluctably grows without limit. Regular readers of this blog will know that I find the premise of the previous sentence questionable at best, but the concern should be acknowledged. Having one category of expenditures that is never revisited would, in any event, be a problem no matter what one thinks about the overall size or growth of government.

Neither of these governance-related arguments, however, is actually addressed to the tax expenditure concept. If one believes that Congress gives inadequate scrutiny -- initially, and over time -- to certain categories of legislation, then Congress should increase its scrutiny. This is not, moreover, a matter of the perfect being the enemy of the good. Under current political constraints, it is much easier to imagine Congress applying higher scrutiny to all budget-related measures than it is to foresee politicians being honest about spending increases. If governance is one's concern, the best response from both theoretical and practical perspectives is to fix the governance, not the labeling.

Finally, it is important to turn from the legislative side of the story to the executive side. Who interprets and enforces the laws at issue here? When a spending program is enacted as a spending program, the cabinet department with subject matter jurisdiction is responsible. When a spending program is enacted as a tax expenditure, it is the IRS and the Treasury Department that bear executive responsibility. From the standpoint of cost-effective administration, there is much to be gained from having a centralized and well-regulated administrator, as opposed to farming out enforcement to a gaggle of overlapping and often ill-equipped agencies.

Last year, I argued (in a FindLaw column and related DoL post) that Congress's increasing reliance on tax expenditures implied that the IRS is the most trusted agency in government. While I was being somewhat playful in making that suggestion, the underlying truth is that even anti-tax Republicans have wholeheartedly jumped on the tax expenditure bandwagon, giving the IRS responsibility over ever-larger parts of federal law enforcement.

Beyond the irony, the larger issue is that the IRS is now -- despite decades of chronic under-funding and political attacks -- extremely good at administering these tax expenditure programs. If we were to move enforcement into other agencies, we would spend large amounts of money replicating the expertise of the IRS across multiple agencies. A former commissioner of the IRS even told me that the other agencies would likely just "borrow" IRS employees to help them set up and run the new enforcement programs.

Beyond institutional competence, the IRS also is the agency that must -- as a matter of its core mission to enforce the income tax -- maintain the best information about people's incomes. Because so many tax expenditures are (appropriately) tied to income-based means testing, the IRS is best positioned to administer many (if not most) tax expenditures, using information that it has already collected. Although it would be possible for the IRS to share such information with other agencies, this raises serious security concerns about highly personal information.

There is always a legitimate concern about having too much power concentrated within one agency. It is probably a good idea to have, for example, multiple inspectors general. As a scarier example, there is a good argument that the overlap and waste from having multiple branches of the armed services is more than outweighed by the resulting inter-branch jealousies, which at the extreme reduces the likelihood of a military coup. Even in more pedestrian situations, it is never clear exactly how much centralization is too much.

Overall, I remain highly skeptical that the growth of tax expenditures is a problem at all, much less one so serious that it deserves the attention of our political leaders. Even so, many of the considerations described above are ultimately fact-based and likely to evolve over time. As it stands, however, the argument for taking a stand against tax expenditures is surprisingly weak.

8 comments:

Doug said...

This would be true if the debate were honest and properly framed - a "tax cut" for kids hockey equipment (and related items which was passed in Canada) would be seen as less objectionable than a subsidy for kids hockey equipment given framing. If the subsidy was only for wealthier parents (or larger for them) it would immediately be seen as bad policy but if it is a tax deduction then it's much harder to grasp that it's really bad public policy.

Tax expenditures could go to the logical conclusion where all government spending was framed as a tax cut - government salaries could be paid as refundable tax credits and government procurement the same way. In fact, doing so might make people sit up and think about the real cost of things like mortgage interest deductability.

I think the point for most is that if a department (or the IRS) had to send cheques to homeowners labelled "Public Subsidy of Home Ownership" then the political debate would change in a good way that would more honestly reframe the debate.

Paul Scott said...

Spending through tax expenditures is inherently regressive. That is my only real objection to the practice.

Neil H. Buchanan said...

Thanks to both Doug and Paul Scott for their comments.

I agree with Doug (and hope I conveyed as much in my post) that, as a matter of first choices, I would prefer honesty and clarity in labeling. I'm just not convinced that the loss from mislabeling is big enough to worry about, especially as we get closer and closer to the bottom of the slope (and given the IRS's expertise).

As to regressivity, it's true that many tax expenditures are classic "upside-down" benefits, but definitely not all. The EITC, for example, is a tax expenditure. So are tax subsidies for higher education, all of which phase out at relatively low incomes. The big ones (housing, pensions, and health care) are almost entirely upside-down, but we could change that without moving them out of the tax code. The Obama administration, for example, at one point suggested capping the value of the mortgage interest deduction at 28%, even for people in higher tax brackets. Wisconsin sets the value of all deductions at 5%, no matter the taxpayer's bracket.

Again, this is not ideal, but it is possible -- and it seems more likely -- to fix the governance issues that I discussed in the post, and the regressivity problem raised in the comments, without forcing politicians to call them spending increases. I wish we could have everything, but this post was about constrained choices.

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