Cut Tax Expenditures to Stimulate the Economy

When Federal Reserve Board Chairman Bernanke announced that the Fed was not prepared to fund additional economic stimulus at this time, the market fell, suggesting strongly that Wall Street disagrees with Republican calls to cut expenditures because deficits have gotten too large. Only when record corporate earnings were announced did the market rise.

The Republican orthodoxy is that letting the market work without government interference and cutting taxes for the rich would stimulate the economy. We now know that is not true, as even Alan Greenspan admitted, but it did result in a massive shift of income from the middle class to the very richest Americans, the top one-tenth of one percent.

There is, however, in the Republican orthodoxy a way of almost balancing the budget, simplifying our overly complicated tax system and stimulating our economy. That would be to eliminate all tax expenditures – the provisions in the tax code that subsidize selected beneficiaries through deductions, credits, exclusions, etc. That would save about $1.2 trillion, which could be used to substantially cut the projected $1.4 trillion deficit and also cut tax rates for middle class Americans. It would be far more stimulative than anything else that has been proposed, while allaying fears about the deficit.

Republicans will almost certainly call eliminating tax expenditures a massive tax increase, but it isn’t. It would allow for taxes to be cut and simplified for most Americans and for the market to be unhindered by the government using the tax code to pick winners and losers. And it would allow for a much smaller and more efficient IRS, no longer administering social programs it is ill equipped to do.

The idea has much going for it but, as things stand, won’t draw serious attention in Congress because the groups that benefit the most are powerful corporate interests. The press, by examining the issue, explaining it, doing interviews – treating it as a subject worthy of discussion – could change that.

As a practical matter, all or almost all tax expenditures would have to be eliminated together because it would be impossible to eliminate them one at a time. Just for example, can you imagine the pressures the oil industry would bring to bear to keep their subsidies? There was bipartisan support for wholesale elimination of special interest provisions or tax expenditures in 1986 under President Reagan. We can and should do it again, even if we have to eliminate some sacred cows, such as mortgage deductions.

The reason the economy is not growing as it should is not for lack of money. Corporations and banks are sitting on record amounts of money but aren’t spending because of lack of demand for their products. The demand isn’t there because middle class people either don’t have the money to buy or because, due to economic uncertainty, they are saving much of what they do have. In the past, the middle class maintained its lifestyle by working harder and longer and by borrowing against the value of homes. Now that home prices have declined, with many below the value of their mortgages, that source of funds is gone.

Cutting taxes, particularly for middle income taxpayers, would go a long way toward creating demand and stimulating the economy which, in turn, would create jobs as businesses spent their profits to expand production, rather than to buy back their stock.

To prevent abuses of future tax subsidies (we all know that pressure to renew them will come the moment they are eliminated), we must require that they be transparent, that a cost benefit analysis be done (no more sneaking in provisions at the last minute in conference) and that they expire unless they pass regular scheduled cost benefit analyses.

States like Oklahoma have found that to be an effective way to help balance their budgets. The only question is whether enough in Congress are willing to pass up the fund raising opportunities that come with special interest tax subsidies. The answer is fairly obvious unless the media explain to the voters what is at stake.

For a round-table discussion of tax expenditures, see Tax Analysts here.

Martin Lobel is a partner in Lobel, Novins & Lamont, a Washington, DC, law firm, and chairman of the board of Tax Analysts (www.tax.org), a source for journalists. E-mail him here.