To fix budget, close loopholes — easier said than done

10/28/2012 12:00 AM

05/16/2014 8:07 PM

In the fiscal year that just ended, the United States spent about $1.1 trillion more than it took in. That gap, the federal budget deficit, was added to the same credit card as the rest of our $16 trillion debt.

The deficit seems enormous. But it turns out we could

eliminate

the gap this year without raising tax rates or cutting spending for any federal program.

Magic? Not really. If we closed every tax loophole — every hidden tax break, exclusion, exemption, credit, deduction — we would raise an estimated $1.1 trillion, almost exactly matching the current deficit.

 But this is not an age of great compromise, where moderates cut the difficult deals that times demand. Rather, a polarized country looks ill-situated to find middle ground even in the face of a broken budget.

So calculate the odds of a political world without much center left finding a way to close all those loopholes in the tax code — fixes that would cause almost unimaginable pain in the boardroom and at the kitchen table. The dynamics turn a seemingly easy answer into a politically impossible one.

Your deduction for mortgage interest would disappear. You’d pay taxes on the value of the health insurance you get at work, and employers could no longer deduct premiums as business expenses. Those 401(k) contributions? Taxable. Charitable donations? High medical expenses? Sorry, not deductible. State and local taxes? Write ’em down. Child care credits? Gone.

City-issued bond income — taxable. Medicare benefits — taxable. Tuition tax credits — history. Veterans benefits — well, you get the idea.

There are more than 200 loopholes lumped in the tax code in a category called “tax expenditures.” And a look at the list demonstrates why the tax code is a twisted, clanking, wheezing monstrosity that is fiendishly difficult to fix.

Tax breaks don’t drop from the sky, after all. They’re put there by lawmakers trying to help some people in America, often at the expense of other Americans.

Homeowners are favored over renters, as are couples with children over the childless. Workers get breaks stay-at-home parents don’t. Meantime, investment income is treated more favorably than labor income. College students get help that high school dropouts don’t. If you buy a stock at $1 and sell at $100, you pay taxes on the gain. If you

die

when it’s at $100, the gain is tax-free to your heirs.

“The tax code is riddled with narrow, targeted incentives for certain behaviors,” said Alex Brill, an analyst at the conservative American Enterprise Institute think tank. “The way we collect our tax dollars is harmful.”

Both Republicans and Democrats this election year have promised to reform the tax system, with the GOP more specific and aggressive on the issue. But Republicans are running into the same problem that sank their predecessors — tax reform is hard because tax policy tries to do several difficult things at once:

•  Raise money for the government;

Distribute the burden “fairly” by basing taxes on the ability to pay;

•  Provide incentives for preferred behaviors such as home-buying and energy conservation.

The result is a bizarre structure in which nearly half of all Americans pay no income tax but the working poor and middle class pay a larger proportion of their income to fund Social Security and Medicare.

“All the different rates, deductions, credits and exemptions under the income tax create huge violations of the principle of equality under the law,” writes Chris Edwards of downsizinggovernment.org.

Mitt Romney has tried to capitalize on taxpayer discontent by offering a plan that he claims “broadens” the base while cutting tax rates. But he has avoided providing some specifics. After all, some of the tax breaks he would have to eliminate to balance the budget are widely coveted.

President Barack Obama and the Democrats have largely ducked the issue, pushing only for higher taxes on high-incomes. Today we look at the specifics of both proposals, as well as areas of potential compromise.

Reaching an agreement could be as economically valuable as it would be politically painful. Spending cuts may be impossible without a revenue compromise, and tax reform done right may be one of the few ways government could encourage capital formation and job growth.

And higher employment may be the only real way to permanently reduce the deficit. More jobs would mean far less federal spending and far more tax revenue, even without any other changes in federal laws or policy.

But government job creation is a ticklish affair, too.

Cutting safety regulations at the car plant might mean more employment, but perhaps more people would be hurt on the job. The automaker might use new tax breaks to hire people — or might provide bigger dividends to stockholders. City Hall might use federal money to hire people to build sidewalks and streets, or the cash could disappear into unneeded pork-barrel bridges to nowhere.

Today we look at job-creation blueprints as well.

All of the topics we’ve examined this fall — Medicare, Social Security, the fiscal cliff, taxes and employment — are extraordinarily complicated problems, but they are critical to our nation’s future. They’ll require enormous amounts of work and compromise before they’re fixed.

In recent years, as we’ve seen, compromise has all but disappeared. The next president, whoever it is, will have to work with Congress to change that.

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