May 10th, 2011

Lawmakers need to dial back expectations for revenue gains from the elimination of tax expenditures in the Internal Revenue Code, panelists said May 6 at the American Bar Association Section of Taxation May meeting.

Each year the Joint Committee on Taxation releases a publication outlining the tax expenditures currently in the tax code and provides what is called an “estimate” for the cost of them over a five-year period. The president’s annual budget proposal also provides a list and revenue estimates, including a 10-year cost for each measure.

The JCT pamphlet contains “a lot of cautionary notes about taking those numbers that are in those tables and treating them as revenue estimates,” said a Senate Finance Committee staffer. “And I worry a little bit because I think a lot of the discussion has been as if they are revenue estimates, and that is not the case.”

The staffer said in some cases the figures will ultimately be close to actual revenue estimates but in other cases, they might not even be in the ballpark because the figures depend on a host of issues including behavioral assumptions. “The numbers in there are really a snapshot of what current policy is against the budget,” the aide said.

Focus on Tax Expenditures Unrealistic

As Congress looks to overhaul and rewrite the tax code, a common theme out of lawmakers, economists, and tax policy experts is that to lower the tax rates and broaden the base, tax expenditures need to be severely reduced or wiped out of the code.

John Buckley, a former long-time Democratic staffer on the House Ways and Means Committee, said he believes that the expectations for what eliminating tax expenditures bring to the debate has jumped far ahead of what is possible from both a technical standpoint and a political standpoint.

“It is much easier to talk about tax reform and focus on tax expenditures in general, than it is do it as a legislative function,” said Buckley, now a professor at Georgetown University Law Center.

There is a lot of rhetoric, he said, about an explosion in the cost of tax expenditures. But the majority is on the individual side of the code. The growth, he said, is largely from congressional expansions of capital gains, dividends, family-related expenditures, and changes in pension and retirement savings rules; an expansion of the health care sector; and the indirect effects of the rate increases since the 1986 tax code overhaul.

Survival Not an Accident

For the past few years, lawmakers in both chambers of Congress and from both sides of the aisle have talked about doing a line-item analysis of the expenditures, but neither the Senate Finance Committee nor the House Ways and Means Committee has issued an analysis.

Part of the reason panelists said, is that contrary to popular belief, the majority of tax expenditures are not benefits given only to the wealthy, and they impact far more constituents than the public realizes. The mortgage-interest deduction, they said as an example, is a middle to upper-middle income benefit that declines as incomes increase.

“We are talking about items here … that were scrutinized in [1986] and recently in the health care debate,” Buckley said. “They all survived that scrutiny, and I think that history indicates that this is going to be a much more difficult road than some of the initial rhetoric would lead you to believe.”

The Senate Finance Committee staffer agreed, saying “They’re not here by accident. These things didn’t survive by accident.”

Running Social Programs Through the Code

From an administrative standpoint, tax expenditures can be a nightmare, National Taxpayer Advocate Nina Olson told the conference. The tax-collecting agency is pulling resources away from its revenue-raising functions and putting them toward its growing policy-delivery function, she said.

“Tax expenditures can be and often are the biggest challenge for the IRS in terms of administration,” she said.

But, she cautioned, not all tax expenditures are alike. Some, like the mortgage interest deduction, are fairly simple to administer because documents can be checked. But others, like the adoption tax credit, are more difficult because of the sheer amount of information that needs to obtained to determine eligibility. “It wreaks all sorts of havoc on our return process and getting refunds out and on our compliance initiatives,” Olson said. “These kinds of issues, because they are high profile, actually bump out normal run-of-the-mill compliance initiatives that the IRS has.”

A wholesale examination of tax expenditures is necessary, she said, to determine the effectiveness of the expenditures and to see if they are doing what Congress intended. She said things that need to be examined include whether the expenditure is a desirable policy, whether the IRS can administer it or if it is more appropriate for another federal agency to handle, and finally, should the IRS administer it.

“Just because it can, doesn’t mean it should, which is my mantra these days,” Olson said.

Buckley said IRS often is chosen to deliver the benefits largely as a function of the budget rules. Noting the “extraordinary” pressure on discretionary spending, he said often if the benefit does not come from the IRS, it will not exist. For example, he said the low-income housing tax credit is run through the code because Congress could not appropriate the funds otherwise.