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Homeowner tax breaks are breaking the budget

October 30, 2005|Maya MacGuineas | Maya MacGuineas is the director of the Fiscal Policy Program at the New America Foundation.

PRESIDENT BUSH'S tax reform panel has ventured into political no man's land. It wants to limit the tax deductions for home mortgages, employer-provided health insurance and state and local taxes.

Individuals and businesses love these tax breaks. Democrats and Republicans embrace them for their own ideological reasons. The constituencies backing them are powerful. But these sacred cows are in desperate need of reform. The Treasury needs the money to close the growing budget deficit, and these tax breaks often benefit the wrong constituencies, even hurting the very economic strata they are intended to help.

The money involved is astronomical, more than $700 billion a year, the Government Accountability Office says. In many years, the tax breaks cost more than the entire discretionary budget, including defense. Of the annual total, health insurance and pension deductions cost $126 billion and $48 billion, respectively. The mortgage interest deduction funnels $76 billion to homeowners.

In reality, these tax breaks are closer to spending programs than tax cuts. By giving deductions and exemptions, the government "spends" part of its potential revenue on programs for everything from housing to education to child care. The programs are run through the tax code to make them look like tax cuts. What's more, tax breaks shift the burden from taxpayers who can claim exceptions to those who can't.

The President's Advisory Panel on Federal Tax Reform is to make its final recommendations by Tuesday. Here are five reasons for reform:

* The benefits often help third parties more than the primary taxpayers. For example, the national homebuilders and Realtors associations champion the mortgage interest deduction not because they care about helping low-wage earners own homes but because the tax break inflates housing prices, which leads to higher profits. The perverse effect is that using the tax code this way actually pushes up prices, thus making houses out of reach for more people.

* These poorly targeted programs often pay people to do what they do anyway, as in buying a home or saving for retirement. That creates little positive behavioral or economic effect, while draining significant funds from the Treasury.

* Because many tax breaks are in the form of exemptions and deductions, they tend to be highly regressive. Often, only taxpayers who itemize realize the savings, and well-off taxpayers, who fall into higher marginal tax brackets, save the most.

* The tax breaks rarely involve the type of thorough review that should go into any new government initiative. The country should engage in a discussion on the role of government in encouraging families to have children, for instance, before creating or expanding the popular child credit. If sufficient thought had gone into creating tax entitlements, would we really have a program that subsidizes millionaires by allowing them to deduct interest on second homes?

* The government does not properly monitor these programs by subjecting them to annual reauthorization. Elected officials rarely even ask if these policies achieve their intended purposes. Once a tax break is adopted, political forces align against reform, arguing that any change amounts to a tax increase.

The path to reform should begin by changing the way we think about these breaks. The government should record them as spending programs, not tax cuts. That shift alone would reveal that the government spends far more than our current accounting methods show. Lawmakers pushing for reform could then show that they are reducing the size of government, not raising taxes.

Furthermore, multiple tax breaks for such things as dependents, education and saving should be consolidated. Turning deductions into credits would potentially save hundreds of billions of dollars a year by better targeting the programs. And Congress should build better oversight mechanisms into the annual appropriations process to monitor programs to see if they are meeting their objectives.

One note of caution: Though the tax reforms of 1986 broadened the tax base and lowered rates, many of those breaks closed corporate and individual loopholes. Today, exemptions and deductions are often linked to specific social and economic policies, whether for education, retirement or healthcare. If those breaks are eliminated merely to save money to pay for other tax cuts, it could harm specific social policies. If tax breaks for health insurance were curtailed, for example, the savings arguably would be better spent to expand and improve healthcare, rather than to pay for eliminating the alternative minimum tax, as the tax panel will suggest.

Because the panel is daring to suggest reform of these sacred tax cows, many opponents are pronouncing its findings dead on arrival. But as many tax economists will tell you, reform in this area is long overdue. If the president and Congress are serious about reform, they should consider going even further than the panel will recommend.

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