If direct spending is frozen, might as well cap tax breaks, too

To reduce the deficit, tax subsidies should be thought of as spending.

By , Guest blogger

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    Some on Capitol Hill are proposing to freeze direct spending on some domestic programs to reduce the deficit. Are tax subsidies just spending in disguise?
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Both President Obama and congressional Republicans want to cap some domestic spending programs as a way to reduce the budget deficit. Leaving aside for the moment whether this is a productive strategy (I think it is not), it raises an interesting question: If Congress is going to freeze direct spending, why shouldn’t it also cap those tax subsidies that are essentially identical to spending?

These tax expenditures are effectively spending programs run through the revenue code. They include the tax exclusion for employer-sponsored health insurance, the mortgage interest deduction, tax-free interest on state and local bonds, and dozens of others. Think of it this way: Congress could write you a check for, say, $300, to help underwrite your monthly mortgage payment, or it could give you a deduction that cuts your taxes by the same $300. Economically, it makes no difference.

Congress sometimes distributes these subsidies through the tax code because it is administratively more convenient. But often it does so merely because it is politically expedient. These days, nobody wants to propose new spending. But when it comes to tax cuts, the line stretches from one end of Pennsylvania Avenue to the other. Just look at what happened last December when Obama and Congress agreed to a tax package that will add $4 trillion to the national debt over the next decade.

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Whatever you want to call these tax preferences, it only makes sense to treat them as what they are, which is to say taxpayer dollars directed into the pockets of those who do what government wants them to do. If we are going to cap some direct spending (at least for the 12 percent of government that the various proposed freezes seem to target), we ought to do the same for the tax deductions, credits, and exclusions that are effectively the same thing.

Keep in mind that spending-like tax preferences add about as much to the deficit each year as the direct spending Washington wants to freeze. The Congressional Budget Office figures these targeted programs will cost about 4.5 percent of Gross Domestic Product (or about $570 billion) in the coming year (the various caps would exclude money for defense and homeland security, as well as the entitlement programs such as Medicare, Medicaid, Social Security, and interest on the debt).

There is great debate about how much of the $1 trillion-plus in annual tax expenditures is actually spending in drag. For instance, special tax treatment of capital gains is considered a tax expenditure but does not substitute for spending. Still, a conservative estimate is roughly half of these preferences—about $500 billion or $600 billion—is spending-like. My Tax Policy Center colleagues Donald Marron and Eric Toder estimate these credits, deductions, and exclusions accounted for about 4 percent of GDP in 2007, and I suspect are somewhat more today.

In addition, while CBO projects that the targeted spending programs are scheduled to remain flat this year (and actually shrink as a share of the growing economy), TPC projects that tax expenditures will increase by about 0.5 percent this year compared to 2010 (after that, it all depends on what happens to the billions of dollars in “tax extenders” that Congress has routinely continued one year at a time).

I’m not saying that actually freezing tax expenditures would be easy. It would not. But I am suggesting that when we consider how to cut the deficit, we need to think about spending-like tax breaks in the same way we think about direct spending.

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