Tax Reform and the Size of Government
As we begin to enter the dog days of summer, the weather is not the only thing that is heating up. The tax reform debate is beginning to escalate also as Senate Finance Committee Chairman Max Baucus (D-MT) and House Ways and Means Committee Chairman Dave Camp (R-MI) begin their tour of the U.S. to drum up support for reforming the tax system.
There are many different reasons to take up tax reform including making the code simpler, fairer and more conducive to economic growth, but a recent paper by Donald Marron and Eric Toder of the Tax Policy Center makes another point: tax reform could shrink the government's overall role in the economy even as it raises revenue. Marron and Toder argue that the true size of government may be hidden by traditional statistics, since most tax expenditures count as tax cuts in the budget instead of spending programs:
How big a role the government should play in the economy is always a central issue in political debates. But measuring the size of government is not simple. People often use shorthand measures, such as the ratio of spending to gross domestic product (GDP) or of tax revenues to GDP. But those measures leave out important aspects of government action. For example, they do not capture the ways governments use deductions, credits, and other tax preferences to make transfers and influence resource use.
We argue that many tax preferences are effectively spending through the tax system. As a result, traditional measures of government size understate both spending and revenues.
The Joint Committee on Taxation estimated the total value of tax expenditures at nearly $1.3 trillion in 2013, and that total is projected to rise to almost $1.6 trillion by 2017. While there are various types of tax expenditures, they refer specifically to two categories of tax expenditures: clear spending substitutes and broad choices of tax structure. In their words, clear spending substitutes are defined as, "tax expenditures that encourage selected activities or aid specific groups of taxpayers and could be replaced by similar programs delivered as direct outlays." On the other hand, "broad choices of tax structure" refer to choices in the tax policy design, such as savings preferences which could be said to be a move towards taxing consumption rather than income, and are not associated with any clear spending objective. They explain:
Policy makers have long recognized that many social and economic goals can be pursued using tax preferences, not just government spending programs. Such preferences are recorded as revenue reductions, making the government appear smaller, but often have the same effects on income distribution and resource allocation as equivalent spending programs (Bradford, 2003; Burman and Phaup, 2011; Marron, 2011). A complete measure of government size should treat these preferences as spending, not revenue reductions. Doing so raises measures of both spending and revenues, without affecting the deficit, and gives a different picture of the economic resources that the government directs.
Making these adjustments requires caution, however. It is tempting, for example, to simply add together all the provisions that the federal government identifies as “tax expenditures” and treat those as effectively spending. But that goes too far. Not all tax expenditures are the functional equivalent of spending.
When spending-like tax provisions are included as outlays (and revenues), the federal government in recent years appears about 4 percentage points of GDP larger than traditional budget figures indicate. If tax reform is done in a smart and agressive manner, there is the distinct possibility that smaller government could technically be a result, even if the traditional measure of revenue is increased.
Regardless of the preferences of lawmakers on the size of government, there is a clear opportunity to eliminate or redesign many tax provisions that have had little oversight. Doing so in the context of revenue-raising tax reform would have significant for the budget and the economy.