Of all the deductions woven into the sprawling U.S. tax code, few have been more fiercely guarded than the enormous tax break that lets homeowners deduct the interest they pay on their mortgages.
But as Congress and the White House negotiate the first major rewrite of tax laws in decades, changing the generations-old mortgage-interest deduction — which costs the government roughly $100 billion a year — has gone from far-off possibility to part of the conversation.
The outcome of that debate could have profound long-term effects on homeowners across the country — and particularly those in the Washington area, who tend to benefit from the tax break more than many other Americans due to the region’s hefty home prices and high incomes.
As the Obama administration and lawmakers on Capitol Hill scramble to defuse automatic spending cuts and tax increases set to take effect Jan. 1, a herd of sacred cows — from Social Security and Medicare to deductions for charitable giving and mortgage interest — are in danger of losing their untouchable status.
How much does the federal government actually spend? About $830 billion more than you think.
That’s the conclusion of a recent study by Donald Marron and Eric Toder. They analyzed so-called tax expenditures — the deductions, breaks and loopholes that clog the tax code — and sorted them into two groups: “spending substitutes” and “tax policy design.”
The tax policy expenditures “represent broad choices in tax policy design but are not associated with any clear spending objective.” Marron and Toder cite the treatment of qualified retirement saving plans, which, for good or ill, nudges the tax code toward taxing consumption rather than savings.
Other expenditures, however, are simply government spending programs by another name. The mortgage-interest deduction, for instance, is a spending substitute: it seeks to “subsidize identifiable activities” — homeownership in this case — and could easily be designed as a spending program in which the government sends homeowners an annual check. Bloomberg View columnists Justin Wolfers and Betsey Stevenson have proposed that we “replace all tax expenditures with explicit subsidies - -that is, with actual federal payments — so we can really see the costs and debate all spending programs on an equal footing.” For spending-like expenditures, at least, that’s a pretty good plan.
Marron and Toder counted about $600 billion of such expenditures in the 2010 tax code. Add in $230 billion in “user fees” that are counted as “negative spending” but are more like tax revenue, and you reach the $830 billion total — “almost 30 percent more than officially reported.”
Some in Washington see this number and their eyes light up: It’s tax reform time! Democrats can get more revenue. Republicans can cut effective federal spending. Taxpayers can get a simpler code. And the economy can get a boost from a tax regime that does less to distort the workings of the free market.
They’ve even got a model: That’s how the 1986 tax reform worked. We cleared out much of the code’s underbrush and used the savings to lower rates. Now, the undergrowth of expenditure is larger even than it was in 1986. In addition, there are the Bush tax cuts, which are set to expire at the end of this year. There has never been a better time, they argue, for tax reform.