Tax Policy's Dirty Secret

Yesterday, the Senate Finance Committee held a hearing asking the question, "Is the Distribution of Tax Burdens and Tax Benefits Equitable?" To ask the question acknowledges tax policy's dirty secret: it isn't just for raising revenue, it's also for spending. Shh! This spending, know as tax expenditures, amount to about $1 trillion a year. To put this in perspective, this is more than Social Security, Medicare and Medicaid, or Defense. Like most other types of spending, some of it's good, some of it less so. Despite it's size, tax expenditures evade scrutiny procedurally since they bypass the annual appropriations and politically since they can masquerade under the auspices of tax cuts and most who occupy elected office don't see raising taxes on their constituents as a winning reelection strategy. What these constituents don't know, and what some people go to great lengths to obscure, is how little they benefit from them. As Max Baucus, the chair of the committee explained:

"The U.S. has a fairly progressive income tax system.  The tax brackets rise with income. 

But we also must consider the tax incentives that affect a person’s tax liability and bring down tax rates. 

Two prime examples of this inequality are deductions and exclusions.  Many of these incentives only benefit people who earn higher incomes, and the size of the benefit they receive is also often dependent on income.

Look, for example, at the charitable deduction.  Only families who itemize their tax returns are able to take advantage of this deduction, and only one-third of taxpayers itemize their returns.  That leaves two-thirds of all Americans unable to receive a tax benefit for charitable deductions.

Among those who do receive the deduction there is also a disparity.  A taxpayer with a 35 percent tax rate saves 35 cents in taxes for every dollar given to charity, while a taxpayer with a 10 percent tax rate only saves 10 cents for every dollar they give.

Take, for example, two taxpayers making $1,000 donations for the Alabama tornado relief efforts. This donation would cost a taxpayer with $35,000 in income $1,000 after taxes because they almost certainly would not itemize.  But this same donation would cost a taxpayer with $435,000 in income much less; $650 after the benefit."

That's hardly progressive. In many cases it isn't practical either. Those examples could have just as easily have included a number of incentives that encourage saving and building assets, most of which are highly concentrated among higher income households. Spending is only an investment if it produces returns. Paying higher income households money to do what they would have done anyway is a poor return. If the policy goal is to increase savings and assets, directing resources on those households who are in need of that assistance and for whom that incentive will result in the behavior being incentivized, there are better ways to go about doing that.

There are questions more nuanced than "do you want to pay more taxes" that need to be asked if changes to our tax code are to have a meaningful impact on the balance sheet of the country and families. As Senator Baucus puts it:

"As we focus on tax reform...We should consider whether our tax system should take these disparities into account in some way, and we must question whether our tax code can better promote economic mobility and opportunity."

Simply put, yes.