The Top Three Ways to Cut Taxes and Still Save Revenue

In his 2012 budget proposal, Rep. Paul Ryan (R-WI) lays out a plan to lower the top individual and corporate tax rates from 35 percent to 25 percent. This much cutting should mean big revenue losses for the federal government, which already gave up a chunk of its income when officials extended the Bush tax cuts for all income brackets last December. However, Ryan asserts that he can make his cuts revenue neutral by nixing tax expenditures—loopholes, breaks and preferences in the the tax code—simultaneously.

There's just one problem: Ryan has yet to say what those expenditures are.

The promise, however vague, sounds good. Most people can agree that a simplified system of taxation is preferable to a more complicated one. Indeed, at, Jacob Sullum argues that complications are as inconvenient as they are expensive, and laments that "[t]he federal tax code, which in 1913 could be published as a single 400-page book, today occupies some 72,000 pages."

Were Paul Ryan to take on the plethora of credits and deductions that contribute to an increasingly complicated tax code, history might also be on his side. In 1986, President Reagan brokered a deal cutting corporate taxes and slashing the top individual tax rate by 22 percent—and yet, tax revenue increased, in fact correcting course after receipts from individuals and corporations took an uncharacteristic dip in the first half of the decade.

But there were two significant tax breaks that 1986 reform didn't touch; another one was addressed, but the change has since been undone. According to Dr. Eric Toder, a tax policy expert at the Urban Institute, if Paul Ryan or anyone else in Washington seeks the kind of revenue neutral, double-digit tax cuts he's proposing, confronting these three tax expenditures is a great way to start.

1. The exemption for employer-provided health insurance

Three-fifths of Americans under the age of 65 receive health coverage through their employer. The federal government doesn't include the cost of these plans in their estimation of a person's income, even though the employer provides that money the same as if it were a wage or salary. The Congressional Research Service estimates that taxing employee health plans the same as employee income would raise "several hundred billion dollars a year, depending on exactly what is repealed and how workers and employers adjust."

Dr. Toder says that there may have been good reason to adopt the exemption in the first place, but in addition to being an expensive tax preference, it contributes to a flawed health care system.

A lot of people get left out of [the current system], it's a big cost for businesses, some are dropping off in coverage, and one of the reasons for health care reform passed last year was to close those gaps. Before that, you could argue, well, you need some kind of preference to encourage employers to establish these plans. The downside is, that preference was open-ended, so maybe insurance plans were more generous than they should have been and helped to drive up health care costs.

Now that we have The Affordable Care Act and people will in a few years have these other ways of getting insurance through exchanges, maybe you don't need this subsidy on the employer side anymore. But that's assuming we keep health care reform.

2. The mortgage interest deduction

The United States is one of only three developed countries that allow homeowners to reduce their taxable income by the amount of interest paid on their mortgage; the Netherlands and Switzerland are the other two. In the Obama administration's 2010 budget, the White House estimated that eliminating the deduction would save $208 billion over the next decade.

It also doesn't really do what it's supposed to do, or what we might want to do for home ownership in America. Dr. Toder explains:

We think it might promote more home ownership, that's the rationale. largely benefits upper middle income taxpayers, and most of the benefit goes to people who would have owned homes anyway. Probably what it's mostly doing is not so muich encouraging people to own homes, but making it possible for people who own homes to have bigger ones, or more expensive ones. It's increasing the size and value of housing stock, but not necessarily home ownership. The question is, why do we want people to put money into housing and to borrow to do that instead of saving more and putting that into stocks and bonds and making it available for business investment?

A counterargument is, well, if you took [the deduction] away, you'd kick the props out from under the housing market—not something you want to be doing this year.

3. The capital gains tax

The 1986 tax reform subjected capital gains—profits from the sale of stocks, bonds and real estate—to the same treatment as regular income. This had the effect of raising revenue; but in the decades since, the tax rate for capital gains has dropped precipitously. Dr. Toder says that restoring capital gains to the same status as income would be a step in the right direction.

Capital gains were taxed at the same rate as ordinary income after '86. The top rate was 28 percent. When Bush I and then Clinton raised the top income tax rate, that made capital gains preferential; but then Clinton lowered it to 20 percent and [George W.] Bush lowered it to 15 percent, so the capital gains rate is now a substantial preference. In fact, it's the lowest capital gains rate we've had in modern history. I think that's one of the things we should look at, certainly.

These three measures are just the beginning. There's a litany of less expensive, more specific tax breaks and preferences that could probably be traded for lower marginal rates, like subsidies for oil and natural gas extractors. However, in the absence of specific proposals from Representative Paul Ryan, he leaves it to the writers of the tax code to come up with these savings.

Which might be shrewd, politically. The most expensive deductions, credits, etc., are among the most popular, and definitely impact the most people.