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Another Way To Curb Deficits

Rein in the spending hidden in the tax rules.

May 30, 2011, Vol. 16, No. 35 • By MARTIN FELDSTEIN
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I have analyzed the revenue effects of such a plan in a study with Daniel Feenberg of the National Bureau of Economic Research and Maya MacGuineas of the Committee for a Responsible Federal Budget (our paper, “Capping Individual Tax Expenditure Benefits,” is available online). We found that if a 2 percent cap were in effect in 2011 it would result in additional tax revenue of $278 billion. That’s the extra revenue for just a single year. In a decade it could produce more than $3 trillion of additional revenue, enough to achieve a substantial reduction in the national debt while also permitting cuts in personal tax rates.

The tax expenditure cap could also play a key role in a failsafe plan. The tax expenditure cap could initially be set at a larger percentage of adjusted gross income, thus producing less revenue, but could be scheduled to become a tighter cap if additional revenue is needed. An initial cap of 5 percent of adjusted gross income would produce revenue of $110 billion in 2011. If the other outlay cuts and the rise in revenue resulting from economic growth brought the deficit down along an agreed path over the coming decade, the 5 percent cap could remain. But if deficits remained unacceptably high, the cap could be reduced to 3 percent or 2 percent.

President Obama has said that he would include reductions in tax expenditures as part of a failsafe plan to achieve reductions in future deficits. That is a welcome sign, but it is important how those reductions are achieved. To be seen as fair and to be capable of raising substantial revenue, they should apply to all deductions and to the health insurance exclusion. The limit should apply to all taxpayers and not just to high-income taxpayers, as the president suggested when he proposed limiting the tax rate used for tax deductions to 28 percent. But a broad cap applied to all taxpayers should be a central part of the deficit reduction plan and could be used as an automatically triggered failsafe option.

Martin Feldstein is a professor of economics at Harvard. He was chairman of the Council of Economic Advisers from 1982-84.

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