How a Former Reagan Advisor Proposes that Barack Obama Could Balance the U.S. Budget

 

ATLANTA— Martin Feldstein wrote a great column that was published over the weekend in the Washington Post about how Barack Obama and Congress could reduce the budget deficit without technically raising taxes.  To do so would require that Mr. Obama go after one of the holy grails of the U.S tax code: federal tax expenditures.  Tax expenditures cost the federal government hundreds of billions in lost revenues each year.  By reducing them, Barack Obama could close the deficit. 

The trouble with this approach, however, is that tax expenditures (or, tax deductions) are beloved by liberals and conservatives alike.  Oddly, they remain the only method of government subsidy and federal wealth redistribution that many conservatives consistently support.  Going after tax expenditures would be a major uphill political battle.  Would it really be worth it?

Martin Feldstein is a professor of economics at Harvard and is a former chair of Ronald Reagan’s Council of Economic Advisors.  He is another vocal economist whose op-ed pieces I enjoy reading.  His pieces are usually succinct and very insightful.

As to Mr. Feldstein’s proposal, I believe he is headed down the right path.  I believe many conservatives are going to need to really change their perspectives on tax expenditures if we are going to have serious discussion of tax reform in the coming years.  Reducing or eliminating tax expenditures will bring us closer to balancing our budget.  More importantly, it will reduce the means through which Congress meddles in our economic choices and behaviors.

The vast majority of Americans probably have not given much thought to what tax deductions truly are.  Former Treasury Secretary John Snow gave a great illustration via a quote in the book I.O.U.S.A.  To make the nature of tax deductions more evident to taxpayers, Mr. Snow stated that Congress should make Americans pay the full tax rates they owe on their income. To the extent taxpayers engaged in any activities previously subsidized through income tax deductions, the Treasury Department should instead write them a check to reimburse them for a portion of their expenditures.  Viewed in this way, it becomes clear how much of a subsidy tax deductions truly are.

Tax deductions are just another form of government spending.  The only difference is that they are netted out of federal revenues via the tax return rather than disbursed via checks.  Through their existence, tax deductions subsidize and incentivize myriad economic decisions, including buying homes or working for employers that provide health insurance benefits.  The incentivized behaviors in themselves are not bad, but to the degree they are favored over other activities, such as renting or becoming an entrepreneur, they can have unintended, negative consequences.  Truthfully, reducing or eliminating tax deductions could have myriad positive impacts on the economy beyond balancing the budget.

The proposal to reduce tax expenditures to close the deficit is not unique to Mr. Feldstein.  His article was written in reference to similar proposals made by Barack Obama’s Debt Commission.  Paul Ryan has included a similar proposal in his Roadmap for America, in which Mr. Ryan would allow Americans to file taxes either under the current income tax model or under a model in which they paid a lower flat tax, with few deductions. 

The basic idea is that by reducing deductions, federal revenues will increase.   Further, there is an underlying belief that federal income tax compliance will increase once the tax code is simplified, also increasing aggregate revenues. 

Of course, as you can imagine, reducing or eliminating income tax deductions would increase actual taxes paid for all Americans.  Therefore, all of these proposals are accompanied by a proposal to reduce the overall income tax rates to partially offset those tax increases. 

Where Mr. Feldstein’s idea differs from many of the other recent proposals is that he states “Congress should cap the total benefit taxpayers can receive from the combined effect of different tax expenditures. That cap could be set as a percentage of an individual’s adjusted gross income and perhaps subject to an absolute dollar amount.”  This is a way to address the political difficulty of reigning in tax expenditures. It would be less offensive to special interest groups, but would still cap the negative financial consequences of the expenditures themselves.

Mr. Feldstein’s proposal is novel and worthy of consideration.  However, I’m not so sure it increases income tax simplicity. Further, it leaves the door at least partially open for government subsidies through the tax code. 

For my part, I favor Paul Ryan’s two system approach, as I believe it would move us closer to a flat tax policy across the board.  I think many Americans would favor the simplicity of being allowed to file an income tax form under an alternative, flat-tax scheme.

But in the end, what is really important to me is that all of these policy proposals result to varying degrees in a reduction to the negative, unintended consequences of tax expenditures. I believe they are incremental movements in the right direction. Income tax deductions are just another means by which government meddles in economic decision-making. 

To the degree each of these proposals moves us further away from Congress governing our behavior through the tax code, the better off we will be.  To the degree they facilitate balancing the budget, more power to them. 

Here’s to hoping Barack Obama and Congress give them serious consideration in the coming months.