Tax Policy Center Analysis Shows Tax Reform Trap May Lie Ahead

How hard is it to cut tax preferences, like the mortgage interest deduction and the exclusion for employer-sponsored health insurance, to pay for lower tax rates?  Very hard, an excellent new analysis from the Urban-Brookings Tax Policy Center (TPC) shows.

For example, we’d have to cut major tax preferences by an eye-popping 72 percent to pay for the rate cuts that some policymakers have proposed.

All of that would make the tax code less progressive:  people in the top fifth of the population would get a net tax cut, on average, while people in the other fifths would face a tax increase. And we wouldn’t get any deficit reduction, since all the savings from cutting tax preferences would go toward offsetting the lower rates.

The new TPC report is an important warning that tax reform could easily become a trap.

Here’s the issue.  As our recent report on the “tax reform trap” explains, there is broad agreement that budget deficits are on an unsustainable long-term path, and many policymakers recognize that we’ll need more revenue to help reduce them.  Yet much of the talk in Congress is about tax reform to “lower the rates and broaden the base.”

Cutting tax preferences sounds appealing in the abstract, we explained, but cutting specific tax breaks enough to pay for big new rate cuts — let alone to pay for the rate cuts and help reduce deficits — will be extremely difficult.  And those proposing rate cuts haven’t offered specific cuts in tax preferences to help pay for them.

The TPC report shows just how difficult the challenge will be.  In one scenario, it assumes that policymakers cut current rates by 20 percent across the board and eliminate the alternative minimum tax, noting, for instance, that these are parts of Governor Romney’s tax plan.

The report also assumes that policymakers want to raise as much revenue as if we made all of President Bush’s tax cuts permanent.  (That’s a very low revenue target; over the next decade, it’s more than $4 trillion less than the tax system would raise if we let the tax cuts expire as scheduled.)

The report then asks how deeply we would need to cut some of the largest tax expenditures — relating to mortgage interest, employer-sponsored health insurance, charitable giving, and state and local taxes, as well as many smaller ones — just to pay for the rate cut.

TPC’s answer:  72 percent.  It’s almost unimaginable that policymakers would agree to shred popular tax breaks like this.