Tax reform impossible

How Congress made tax reform impossible

The tax code became a shadow budget for lawmakers to hide spending — and now dozens of programs need to be slashed.

By DANNY VINIK

In 1977, with the economy struggling and unemployment above 7 percent, Congress launched a new job-creation program. It was done through the tax code, offering employers up to a $2,100 credit for each new hire. Over the past 40 years, the program has cost tens of billions of dollars and been reformed dozens of times. Today, it’s small and targeted: Employers receive the subsidy only for hiring specific individuals, including food-stamp recipients, disabled veterans and, as of 2015, the long-term unemployed.

Helping the most disadvantaged Americans find work is the kind of thing that Democrats and Republicans agree on, even in today’s politically charged atmosphere. But as part of their once-in-a-generation tax overhaul, House Republicans want to eliminate the decades-old program. If their plan passes, employers will stop receiving a tax credit for hiring disabled vets and long-term unemployed people—a change that experts believe would make it harder for people in some of the toughest situations to find work.

“It would be a significant barrier to us trying to encourage people to hire people with autism,” said Tammy Morris, chief program officer for the Autism Alliance of Michigan, which opposes the provision.

The Work Opportunity Tax Credit is one of dozens of small programs on the chopping block in the GOP tax plan—and whose upset beneficiaries are making tax reform a political minefield. The plan would also cut tax breaks for teachers who buy supplies for their classrooms, for investments in impoverished areas and for workers who move for a new job. As more analysts read through the 429 pages of the bill, released last week, it has become clearer that “tax reform” entails an en-masse rollback of such small-scale benefits—programs that go unnoticed by the vast majority of Americans, but are crucially important to their beneficiaries.

The large number of impacted groups are already causing significant friction for the reform, and it’s likely just beginning. Disability-rights groups, like the Autism Alliance for Michigan, and veterans’ groups, including Veterans for Foreign Wars and the American Legion, are speaking out against the removal of the WOTC, which “definitely incentivizes employers to hire veterans,” said Ariel DeJesus, an assistant director at the American Legion. Housing groups and state and local governments are fighting to keep a tax break that supports the development of low-income housing. Pro-life groups already convinced House Republicans to restore a $3.8 billion tax break for adoptive parents, which was repealed in the original bill.

And these calls are only likely to grow louder and more numerous now that the Senate GOP has released its own tax plan, which is expected to repeal or limit many similar tax breaks.

If the sheer number of interest groups might seem to make ambitious tax reform impossible, there’s a very simple reason, and the blame lies with Congress: As the 1977 law suggests, Congress for decades has been using the tax code to stash subsidies that could never get in through the front door of the budget process. Thanks to both Democrats and Republicans worried about being tagged as spendthrifts, the U.S. tax code has grown into a vast shadow budget, a massive law stacked with social programs, incentives for economic growth, and even special subsidies for sports stadiums and rum manufacturers.

Since the early 1990s, such shadow spending – known to budget wonks as “tax expenditures”— have grown from around $600 billion to $1.2 trillion, after adjusting for inflation. Much of this growth has come from large, well-known tax breaks, like the exclusion for employer-sponsored health insurance and the mortgage interest deduction, which would be limited under the GOP bill. But the sheer number of tax expenditures has also grown by more than half during that period as well.

Since these social programs are buried in the tax code and don’t look like spending, they are politically popular and make tax reform devilishly difficult, said Michael Strain, director of economic studies at the American Enterprise Institute. “It shows up as a decrease in their tax bill rather than an increase in the amount of government spending they receive,” he said. “But it is government spending.” He added about the huge number of tax expenditures, “It’s so big and comprehensive. How do you get arms around it?”

The result is that the GOP’s tax plan is running afoul of dozens of groups—including numerous small but sympathetic constituencies who benefit from the nearly $1 trillion worth of breaks in the existing tax code. Morris described a small cleaning company that her organization works with that relies on the Work Opportunity Tax Credit to offset the costs of recruiting and training people with disabilities. “They would have to stop that practice, which means that those individuals will go back on state-funded support,” she said.

It’s popular on both sides of the aisle to portray the tax code as filled with special interest giveaways, and the GOP plan does eliminate some tax breaks that accrue almost entirely to the rich, like a subsidy for sports stadiums. But many of the tax breaks targeted by the House Republican bill have clear social purposes, encouraging certain behaviors that are widely seen as beneficial for American society. That includes a deduction for employer-provided dependent care, which helps workers afford care for their children or spouses with disabilities, as well as a tax exclusion on interest on private activity bonds, which state and local governments use to fund low-income housing and has helped attract billions of dollars in private financing. The plan also eliminates two deductions for work-related moving expenses; economists believe such labor market churn is crucial to a strong labor market. Other tax breaks targeted for repeal include a deduction for employer-provided transportation benefits, a credit for the rehabilitation of historic buildings and a credit for small businesses to improve accessibility for disabled individuals.

Christopher Howard, a political scientist at the College of William and Mary and author of “The Hidden Welfare State” about social policies buried in the tax code, described this process as “how we build a welfare state when we don’t really trust government that much.” He added, “Often Republicans and Democrats meet in the middle, where Democrats would like to expand government directly and Republicans don’t want to expand it. And so they agree to expand it indirectly.”

The House GOP plan is guided by the philosophy that eliminating tax breaks and cutting tax rates will unleash economic growth, creating better economic outcomes for everyone. They want to reduce the size of the tax code by wiping away special interest giveaways and limit even broadly popular tax breaks, like the mortgage interest deduction, to partially pay for their tax overhaul. But within that broad framework, there are plenty of inconsistencies.

For instance, the GOP plan eliminates the New Markets Tax Credit, which encourages businesses to invest in economically downtrodden areas, but doesn’t affect a very similar tax credit for investing in so-called “empowerment zones,” which are poor urban and rural areas. (Empowerment zones were championed by House Speaker Paul Ryan’s mentor, former Rep. Jack Kemp.) Originally, it eliminated a deduction for adoption expenses—but it leaves untouched a tax exclusion for payments to foster parents.

Republican leaders argue that, broadly speaking, increased economic growth from lower and simpler taxes will offset any other the losers. Asked at a POLITICO Playbook event last week about the proposed repeal of the tax break for adoptive parents, House Ways and Means Chairman Kevin Brady, who is the father of two adopted sons, called it a “tough choice.” He added, “These are tough calls and the call is this, do we want a tax code that has special provisions you may use once in your life, or do we want a tax code that lowers rates and you get help every year of your life?” On Thursday, facing pressure from pro-life groups, Brady introduced an amendment to retain the adoption credit.

Many experts believe that for the people affected, no amount of additional growth will make up for the loss of these targeted tax breaks. It’s near impossible for economists to tally the costs of the veteran who doesn’t get a job because the WOTC was repealed or the fast food worker who can’t afford to move to a better paying job. But for individuals, those costs are real, even if they are just a small piece of a $1.5 trillion tax cut that would reshape the U.S. economy.

This problem isn’t unique to the GOP tax plan. All politicians talk about cleaning up the tax code and eliminating special interest loopholes. But any plan that wants to significantly reduce the number of tax breaks is inherently going to face tough choices about deductions and credits that serve real social purposes and for which the government doesn’t have ready replacements.

There’s a way to address these programs, of course, but it wouldn’t help Republicans hold their plan to $1.5 trillion in revenue losses, which is required by their budget. Instead of simply wiping away these tax breaks to pay for other tax cuts, they could be converted into government spending programs, funded each year by Congress through the annual budget process. For instance, the Work Opportunity Tax Credit could become a subsidized employment program; funded at the same level as the tax credit, it would cost around $400 million a year. Congress could do the same with other tax breaks, from the deduction for adoption expenses to the subsidy for workers who move for a new job. Such a plan could be deficit-neutral and more transparent, while giving lawmakers a chance to fix the flaws that many of these programs have built up over the years. And it would simplify the tax code. But there’s a reason Congress is unlikely to take that route anytime soon: It would give the spending nowhere to hide.