David Schizer (Dean, Columbia), A Framework for Limiting Tax Expenditures: Programmatic Incentives, Excess Burden, and Distribution:
To rein in unsustainable federal budget deficits, we need to cut spending, raise more revenue, or both. In response, political leaders have begun focusing on an important source of potential savings: repealing or limiting tax expenditures, such as the home mortgage deduction, the exclusion for employer-provided health insurance or other tax provisions that promote “nontax” policy goals. ... Since there are many ways to raise revenue or cut spending – from increasing marginal rates to improving enforcement or scaling back entitlements – how do we know whether repealing or limiting tax expenditures is the right strategy? We need a general framework for identifying the costs and benefits of repeal or limits, as well as an understanding of the tradeoffs among different types of limits. These issues have not been adequately explored in the literature, and this Article seeks to fill this gap. The goal is not to advocate repealing or limiting any specific tax expenditure, which is a fact-intensive inquiry, but to identify key questions that must be explored in deciding whether to do so. The analysis here is relevant whether we choose to use this savings to fund marginal rate cuts or, alternatively, to reduce the deficit without (further) increasing marginal rates.
To identify the welfare benefits and costs of repealing or limiting tax expenditures, this Article explores three sets of questions. First, how valuable are the “nontax” incentives created by a tax expenditure (which this Article calls “programmatic incentives”)? What externalities does it create? Are taxpayer preferences sufficiently elastic for the tax expenditure actually to change behavior? Second, when we repeal or limit a tax expenditure, what are the effects on labor and savings decisions, planning, and administrative costs? How do these efficiency costs compare with the excess burden from raising marginal rates? Third, what is the impact on distribution? Aside from the earned income tax credit and other refundable credits, tax expenditures generally reduce the taxes of high-income taxpayers. Repealing or limiting such a preference, then, is likely to enhance progressivity. This Article also explores three more specific distributional goals in limiting tax expenditures: providing benefits only to low- and middle-income taxpayers; offering comparable benefits to low- and high-income taxpayers; and promoting horizontal equity.
In addition to this framework, this Article makes five new contributions to the literature. First, it introduces a novel classification of tax expenditures, depending on whether marginal positive externalities should be considered on an individual-by-individual basis or in the aggregate. ... Third, and relatedly, this Article shows that sometimes a limit can strengthen the policy case for a tax expenditure. ... Fourth, and more generally, this Article uncovers a series of tradeoffs among our three goals: promoting externalities, minimizing excess burden, and promoting a fairer distribution of tax burdens. ... Fifth, this Article takes issue with a recommendation offered by Lily Batchelder, Fred Goldberg, and Peter Orszag [Efficiency and Tax Incentives: The Case for Refundable Tax Credits, 59 Stanford Law Review 23 (2006)] They argue that tax expenditures generally should not vary with income, so that the default structure should be a refundable credit. In response, this Article argues that uniformity will often not be the right answer, and thus is a flawed default.
Part I uses two concept from the public finance literature -- the marginal cost of funds and the marginal benefit of public projects – to outlines key issues in deciding whether to repeal or limit a tax expenditure. Part II analyzes externality- and elasticity-rationales for doing so. Part III considers how repeal or limits affect excess burden, including labor and savings decisions, planning, and administrative costs. Part IV focuses on distributional rationales for repealing or limiting tax expenditures. Although this Article focuses on policy instead of political economy, Part V surveys political-economy opportunities and challenges associated with repeal and limits. To sum up the other Parts, Part VI reviews twenty-eight potential rationales for repealing or limiting tax expenditures. Part VII surveys seven different types of limits, and the various tradeoffs they present. Part VIII is the conclusion.