A cap on the tax reductions derived from tax expenditures that is equal to 2 percent of each individual’s adjusted gross income would raise more than US$200 billion next year if applied to all of the current deductions and to the exclusions for municipal-bond interest and employer-paid health insurance. Even if the full deduction for charitable gifts is preserved and only high-value health insurance is regarded as a tax expenditure, the extra revenue next year would be about US$150 billion. Over a decade, that implies nearly US$2 trillion in additional revenue, without any increase in tax rates from today’s levels.
Extra revenue of US$150 billion next year would be 1 percent of GDP and could be too much for the economy to swallow, particularly if combined with reductions in government spending and a rise in the payroll tax. However, the same basic framework could be used by starting with a higher cap and gradually reducing it over several years. A 5 percent cap on the tax-expenditure benefits would raise only US$75 billion next year, about 0.5 percent of GDP; but the cap could be reduced from 5 percent to 2 percent over the next few years, raising substantially more revenue when the economy is stronger.
Slowing the growth of government spending for Medicare and Social Security is necessary to prevent a long-term explosion of the national debt or dramatic increases in personal tax rates. Those changes should also be phased in gradually to protect beneficiaries and avoid an economic downturn.
The US’ national debt has more than doubled in the past five years and is set to rise to more than 100 percent of GDP over the next decade, unless changes in spending and taxes are implemented. A well-designed combination of caps to limit tax expenditures and a gradual slowing of growth in outlays for entitlement programs could reverse the rise in the debt and strengthen the US economy. The US’ current budget negotiations should focus on achieving a credible long-term decline in the national debt, while protecting economic expansion in the near term.
Martin Feldstein, professor of economics at Harvard, was chairman of former US president Ronald Reagan’s Council of Economic Advisers and is a former president of the US National Bureau for Economic Research.
Copyright: Project Syndicate