Tax Incentives on the Block as Lawmakers Eye Deficit Reduction

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President Obama and his Democratic allies have made clear they want additional tax revenues to be part of deficit reduction. Republicans have made clear they will not accept any increases in tax rates.

But there's one possible strategy for both sides to get their way: cutting subsidies and deductions in the tax code.

"This is where the revenue deal is to be done,” said Donald Marron, director of the Tax Policy Center and a former economic adviser to President George W. Bush. “I don't think there is the political will to do significant increases in tax rates. The deal to be done is to look at the tax preferences and walk them back in some intelligent way."

Maya MacGuineas of the non-partisan Committee for a Responsible Federal Budget agrees.

"This is an elegant way to kind of thread this needle between those who don't want to raise any revenues for the deficit and those who want to focus on more taxes,” MacGuineas said.

These tax breaks, known as “tax expenditures” or “tax preferences,” add up to about $1.3 trillion a year, more than all individual and corporate tax collections combined.

They've been a favorite of presidents and lawmakers for years, because they're easier to implement than spending programs. But they make government larger than it otherwise seems.

"A lot of this that wouldn't make sense if they were subject to a kind of scrutiny we apply to traditional spending programs," says Len Burman, a Treasury official in the Clinton years. "They get a pass because they're run through the tax code."

Tax preferences were a favorite of President Clinton, Burman said.

“Every time President Clinton felt somebody's pain, there was a proposal for a new tax credit. ... They didn't want to propose new spending programs, because then it would be 'Bill Clinton, big-spending liberal, making government bigger,'" he said, explaining their thinking. " But a tax credit or deduction, that’s a tax cut. That's a good thing."

In fact, just last week, Obama called for new tax breaks for veterans, a far easier lift than a new spending program.

The list of existing tax preferences includes some easy targets Congress has already sought to roll back, such as subsidies for ethanol.

And then, there's one that Democrats rail about day after day, tax breaks for oil companies -- though critics say it's relatively small potatoes, $40 billion over 10 years, MacGuineas said.

"That is nothing to sneeze at, but it is not going to balance the budget," she said, "and it's only going to be a drop in the bucket of what we actually need."

The biggest deductions are far more popular and used by tens of millions of regular taxpayers.

The largest is making employer-provided health insurance tax free. If taxed, that alone would bring in $282 billion a year from workers and their employers.

The home mortgage interest deduction is the second largest at $89 billion a year, followed by tax-free 401(k) savings at $63 billion. That's followed closely by deductions for charitable contributions at $40 billion and deductions for state and local taxes at $38 billion a year.

“The benefits, the value of these subsidies as a share of income increases with income up to the very, very top,” said Berman, who called tax incentives “middle-class or upper-class entitlement programs.”

Others offer businesses tax breaks for accelerated depreciation and capital gains or profits.

But a lot of programs for the poor are also handled through the tax code.

"We chosen to run a significant portion of the safety net through the tax code," said Marron, who points to the earned income tax credit, child credit and deductions for some child care expenses.

Though both liberals and conservatives have their favorites, both parties have a stake in the search.

"That's a tremendous sum of money that can be used to both lower marginal tax rates ... and raise revenue to help close the deficit," MacGuineas said.

But there will be a battle over how much of any savings should be dedicated to lowering tax rates and how much should go to reducing the deficit.

Some analysts suggest using one third to reduce the deficit and two thirds to reduce tax rates, in hopes of boosting economic growth and generating jobs.

Whatever the answer to that question, Burman has a broader one.

"The point is that we should figure out what government is doing -- what we can afford to pay for, and how it can be done in the best way?" he said.