How Obama and Congress Can Really Reduce the Deficit

Last Updated Jul 6, 2011 12:56 PM EDT


President Obama reiterated his position yesterday that any deficit-reduction agreement to unlock the debt-ceiling stalemate must be a " that includes both spending cuts and increased tax revenue. The President will reconvene with Congressional leaders tomorrow at the White House for another round of negotiations (for more on the President's remarks on Tuesday, read on CBSNews.com).

The President's use of the word "balanced" does not mean the White House or the Democratic leadership is insistent on going halfsies between spending cuts and tax hikes. When the Joe Biden-led negotiations broke down 10 days ago, it was reportedly due in part to the Republicans' refusal to accept a deficit reduction plan that generated about 80 percent of savings through spending cuts and 20 percent through increased tax revenue. That's 80-20, not 50-50.


"A Unique Opportunity To Do Something Big"

It's going to take a few more weeks of negotiation, polling, posturing, and down-to-the-wire deal making before we have any clarity on what level of deficit reduction Washington can agree to. In his brief statement yesterday, the President made it clear he wasn't behind a small-ball agreement that does "just enough to make sure that America avoids defaulting on our debt in the short term, but then wants to kick the can down the road when it comes to solving the larger problem of our deficit." Instead, he wants Washington to swing for the deficit-reduction fences. "We have a unique opportunity to do something big," the President said.

If that's the President's goal, however, he must have some more substantive ideas for increasing tax revenue than last week's suggestion that we scale back the depreciation tax break for private corporate jets. Howard Gleckman of the TaxVox blog points out that move might save us $300 million or so a year, while this year's federal deficit is expected to clock in at $1.4 trillion.

The Tax Tussle
With his jibe at corporate jet owners, President Obama was obviously engaging in some base-pleasing posturing intended to force Republicans to negotiate on taxes, or else defend breaks for the very wealthy. That's just politics, and it's where we're currently at in the negotiation process. But at some point, if there is a deal to be done, the negotiating has to turn substantive.

There seems to be rare agreement that outright hikes on income tax rates are off the table for now. But what might be up for negotiation is scaling back so-called "tax expenditures." That's the only-in-Washington way of saying tax breaks. Or as Donald Marron, director of the Tax Policy Center, a joint venture of the non-partisan Urban Institute and Brookings Institute, recently put it in an insightful article in National Affairs, tax expenditures are simply Spending in Disguise.


Spending in the Tax Code: $1 Trillion a Year
The $300 million or so spent annually on that corporate jet tax break is so beside the point. Each year, the Office of Management and Budget is required to add up the cost of the tax deductions, tax exemptions, tax credits, tax deferrals, and preferential tax rates that permeate the individual and corporate income tax codes. The 2012 fiscal budget lists more than 170 such tax expenditures. The total tab comes in at more than $1 trillion, with about 9 out of every 10 dollars in tax spending sitting in the individual tax code. Moreover, what we annually spend in tax expenditures is more than what we're currently spending on Medicare/Medicaid or Social Security as this chart shows:

Source: Cbpp.org

As the debate over tax expenditures heats up in the coming days, it might be helpful to understand where the really big dollars are in terms of our tax-code spending. You can pore through the 170 or so tax expenditures listed in a supplement of the President's proposed 2012 Federal Budget (start at page 242). Or here's a cheat sheet of the 10 largest tax expenditures and their cost in terms of estimated foregone tax revenue for the five years from 2012-2016:

  1. Exclusion of employer-paid health insurance premiums as taxable income to employee: $1.1 trillion
  2. Mortgage interest deduction: $609.2 billion
  3. Step-up treatment of capital gains at death: $357.1 billion
  4. 401(k) contribution deferrals: $356.3 billion
  5. Exclusion of imputed rental income: $302.8 billion
  6. Deductibility of state and local income taxes: $292.3 billion
  7. Accelerated depreciation of machinery and equipment: $269.7 billion
  8. Long-term capital gains (preferential rate): $256.3 billion
  9. Charitable contribution deductions: $248.9 billion
  10. Exclusion of certain employer contributions to employee pensions: $246 billion
That's more than $3 trillion worth of tax expenditures over five years. Note, though, that cutting any expenditure doesn't guarantee an equal increase in tax revenue. With a lot of these expenditures, any policy change would trigger different behavior. For example, if you tax capital gains at ordinary income tax rates, higher-income folks will probably think twice about realizing gains. But at a time when the rhetoric and politics are flying over how to deal with the deficit, it's important to recognize that federal spending isn't simply a function of what we appropriate to various programs. It's also what is spent on all the tax breaks embedded in the tax code. Without raising income tax rates, trimming some tax expenditures is one more way we could address the deficit. And it's an idea embraced in last year's bipartisan deficit commission proposals.

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