With the successful passage of the Tax Cuts and Jobs Act, the Republican Congress and President Trump have passed their most significant legislative accomplishment of the year, and perhaps of their political careers. Tax reform has been a major and unifying goal of the GOP for many years and they just got it done. Sort of.
The premise of tax reform is that our tax code is too complex and provides too many favors to the connected few. The complexity saps growth and the loopholes misallocate capitol by allowing Washington DC to pick winners and losers rather than the market. To address these problems, the slogan for tax reform has always been “lower the rates, broaden the base.” That means instead of taxing some things at higher rates, the government will tax more things at lower rates. The same amount of revenue is collected overall, but in a more efficient and fair manner.
The Tax Cuts and Jobs Act that passed this week is many things, but simplification and base broadening it is not. Before he retired, former Senator Tom Coburn released Tax Decoder, a report analyzing the various tax expenditures scattered throughout the tax code. The report analyzed 165 tax expenditures that cost more than $900 billion annually in lost revenue. These range from the biggest (the employer provided health insurance deduction), the most popular (the mortgage interest and charitable deductions), and the wasteful (Hollywood tax breaks and pro sports stadiums subsidies).
The Tax Decoder points out the problem with tax complexities and spending through the tax code, stating that “the federal tax code is a necessary evil that should be used only to collect revenue to pay for legitimate, essential federal expenditures, such as our national defense. But Washington politicians have manipulated it for their own purposes, whether to support special interests or to encourage certain behaviors or discourage others. As such, the tax code has become a powerful and elaborate system of rewards and punishments used to coerce Americans and manipulate the economy.”
The report also warned of the complications of eliminating some loopholes, highlighting that “while weeding out the tax code may cause some short-term uncertainty for those who have become reliant on tax handouts, the U.S. economy and individual taxpayers would greatly benefit from a simpler, fairer code and lower tax rates.”
How did the Tax Cuts and Jobs Act shakeout? Of the 165 tax expenditures that were listed in Tax Decoder, only four were repealed by the tax law and another eight were limited (most prominently the Mortgage Interest Deduction and the State and Local Tax Deduction). Not only were many tax expenditures saved, but some were even expanded.
A needed caveat is that the value of many tax expenditures is reduced or wiped away by the lower tax rates and the doubling of the standard deduction. But the idea that our tax code should be based on raising revenue in a neutral, fair, and efficient manner rather than spending and allocating capital based on the the whims and wishes of Congress did not happen. And that is a shame.
Here are a few examples of tax expenditures that will stick around:
The New Markets Tax Credit: The New Markets Tax Credit allows banks and other financial entities to claim a tax credit for investing in businesses in low-income areas. But the definition of “low-income area” is so expansive that nearly every community qualifies. Over the last decade, a niche group of investors, such as banks and hedge funds, have formed to maximize their return while maximizing the cost to taxpayers. As of 2007, nearly 40 percent of all NMTC claimants were banks or other regulated financial institutions. The NMTC helped finance a Starbucks in Indianapolis, a bakery in New Bedford, Massachusetts, a baseball stadium in Kentucky, four bowling alleys, six car washes, four coffee shops, a day spa in Alaska, an IHOP in Milwaukee, four law firms, and at least two Mexican restaurants in Colorado and Wisconsin.
The Historic Tax Credit: The Historic Tax Credit provides a 20 percent tax credit against the costs of renovating a building on the National Register of Historic Places, which sounds exclusive until further review that it is fairly easy to get listed and includes 1.5 million buildings and list continues to grow by more than one thousand structures every year. The tax credit has made the American taxpayers co-investors in many mega development projects. The tax credit provided $40 million for the Boston Red Sox’s Fenway Park renovation, handed $10 million over to the Las Vegas Mob Museum, provided $5 million for a site that hosted a Hollywood gala in Beverly Hills, and gave $60 million for a renovation of Miami’s Fontainebleau Resort. It even provided $40 million in taxpayer dollars to the Trump Hotel in Washington DC.
The Pro Sports Stadium Subsidy: The Tax Cuts and Jobs Act also preserves the Professional Sports Stadium subsidy, which allows for professional sports owners to use tax exempt bond financing to construct their privately-owned stadiums off the tax dollars of their fans and non-fans alike. According to a Bloomberg report, since 2000 “$3.2 billion in federal taxpayer money, through municipal bonds, has been used to fund 36 newly built or renovated sports stadiums. The largest federal subsidies, according to [a Brookings] report, include the New York Yankees ($431 million), the Chicago Bears ($205 million), the New York Mets ($185 million), the Cincinnati Bengals ($164 million) and the Indianapolis Colts ($163 million).”
To their credit, the bill that the House originally passed did close down these and many other tax expenditures. However, the Senate decided to keep and expand many, and won out during the conference negotiations. A text analysis of the conference report finds that the House lost on 31 provisions (mainly to eliminate loopholes) while the Senate only lost 8 times.
In the short run, this bill is a win for the American people that will see lower tax bills and bigger pay checks. In the long run, this bill is a boon to DC lobbyists and special interests that will be bolstered by the fact that spending through the tax code is still alive and well. Pair that with several expiration dates of tax provisions built into the and you have a product that will continue to make DC the place to coerce capital flows through Congressional lobbying rather than market forces.
Tax reform was absolutely needed. Instead we got tax cuts without spending restraint through eliminating tax expenditures or federal spending. The tab for those decisions will be picked up by the next generation in the form of higher taxes and lower growth.