Beneath the surface of American government lurks a system of social programs for the wealthy that is consuming the federal budget. It’s time for progressives to do battle with tax expenditures.
As a matter of budgeting, however, there is no difference between a tax break and a social program: both have to be paid for, either by raising tax rates or by adding to the deficit. Eugene Steuerle, a tax economist and political appointee in the Reagan administration, said of the distinction between tax expenditures and direct social spending, “One looks like smaller government; one looks like bigger government. In fact, they both do exactly the same thing.” Certainly their status has not eluded the policymakers who crafted them; the Louisiana senator Russell Long, chair of the Senate Finance Committee from 1966 to 1981 and the father of the Earned Income Tax Credit, said of the term “tax expenditures,” “That label don’t bother me. I’ve never been confused about it. I’ve always known that what we’re doing was giving government money away.”
The largest tax expenditures have been around at least half a century, each the product of inadvertent origins. As political scientist Christopher Howard of the College of William & Mary has observed, policymakers involved in the haphazard array of decisions that generated these policies could not have imagined that they were establishing benefits that by the late twentieth century would gain quasi-entitlement status and cost the nation burgeoning amounts. Of the three most expensive ones, the Home Mortgage Interest Deduction was created first, as part of the original tax code in 1913; the preferential tax treatment of employer pensions was established through a hodgepodge of administrative rulings and congressional statues between 1914 and 1926; and the tax-privileged status of employer-provided health benefits resulted from a similar conglomeration of policies during World War II and in the 1950s. In 2011, these three pillars of the submerged state are expected to cost the nation $104.5 billion, $67.1 billion, and $177 billion, respectively. The cost of each component has ballooned, owing not only to market forces but also to the incentives the policies themselves offer that promote consumption in particular forms—such as the purchase of bigger homes, pricier college educations, or more expensive health care—thus inflating their value.
Remarkably, despite the vast drain such provisions impose on federal resources, policymakers have mostly allowed them to grow unchecked. Unlike direct social spending, they are not subject to the annual appropriations process in Congress, and thus they have been able to snowball while sheltered from the public glare.
Whereas mainstream Democrats have traditionally taken the lead in creating our landmark direct social programs, it was originally Republicans and conservative Democrats who initiated the benefits that operated through the tax code. Doing so enabled them to court their favored constituencies and channel resources toward them, but without creating or enlarging government bureaucracies to distribute the funds.
Over the past three decades, however, tax expenditures have evolved into the template of choice for anyone designing new social benefits. Conservatives have actively promoted and protected them, and moderate and liberal Democrats have realized that it is far easier to build a coalition of support for social provision through the tax system rather than through direct spending. Thus they have become willing accomplices. President Clinton promoted and signed into law higher education tax credits, a policy favored by Republicans as an alternative to direct spending ever since the creation of the Higher Education Act of 1965; he also expanded dramatically the Earned Income Tax Credit. President Obama has treated tax expenditures as a policy tool for achieving a broad array of objectives; tax benefits accounted for 37 percent of the $787 billion stimulus he signed into law in 2009, including everything from expansions of existing programs to credits for first-time home buyers and those who purchased energy-efficient doors, windows, and appliances.
But the broader goals of progressive politics are undermined by tax expenditures. Reducing them is a goal we should embrace. The problems start with their redistributive impact.
Most Americans assume that U.S. government social programs aid primarily the poor and the middle class, but tax expenditures generally shower their most generous benefits on those in the upper reaches of the income spectrum. To be sure, there are exceptions—most notably the EITC, which genuinely aids the working poor, and Clinton’s HOPE credit, which targeted the middle class. But in the main, such policies are upwardly redistributive, despite rhetoric to the contrary.
On the rare occasions when policymakers do actually speak about the Home Mortgage Interest Deduction, they portray it as a middle-class benefit that helps to increase home ownership, a pillar of the American dream. Yet countries such as Canada and Australia manage to have U.S.-level rates of home ownership without offering a home mortgage interest deduction in their tax codes. Moreover, in 2004, 69 percent of the benefits of America’s home mortgage interest deduction were claimed by households with incomes of $100,000 or above—the top 15 percent of the income distribution. That same group also reaped 55 percent of the benefits emanating from the tax-free status of retirement benefits and 30 percent of those from employer-provided health benefits. This is because most tax expenditures reward activities that people with greater resources are better poised to take part in: buying more expensive homes and qualifying for mortgages far bigger than those of the typical home buyer; or obtaining generous employer-provided benefits, whose previously broad coverage has declined sharply, particularly among those with low to moderate incomes. Tax expenditures also exacerbate economic inequality by dramatically reducing the revenues government collects, leaving considerably fewer resources available for the programs like Head Start and Pell grants that benefit lower-income Americans.
Even more harmful to the United States than the economic
effects of these submerged state policies are the effects of the politics they generate. The vested interests that profit from these policies—ranging from the real estate and health care industries to the nonprofit foundation world—are keenly aware of them and invest heavily in their political capacity to preserve and defend core policies. For example, the amount the real estate sector contributed to campaigns more than tripled between 1992 and 2008, growing from $43 million to $138 million in 2010 dollars. Its spending on lobbying escalated far more quickly, increasing by 73 percent between 1998 and 2009.
Ordinary Americans, by contrast, have little awareness of the very existence of such policies, even if they are beneficiaries themselves. In the 2008 survey I mentioned above, respondents were asked whether they had “ever used a government social program, or not” and later queried on whether they had ever utilized any of nineteen different social benefits. Those who had benefited from tax expenditures were most likely to deny having used a government social program—for example, 60 percent of those who had used the Home Mortgage Interest Deduction gave that answer.
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