Tax Expenditures = America’s Biggest Spending

Justin Wolfers:

If you’re at all like us, chances are you’ll spend Tuesday [April 15th] finishing your taxes. As you search for every last deduction and credit, it’s worth asking: Does any of this make sense?
Here’s a way to see through the fog. Instead of looking at all the breaks for mortgage interest, health care, retirement savings and so on as deductions, picture the government writing you a check for each item. This equivalence between tax deductions and government spending leads economists to call them “tax expenditures.” Reformers have hit on an even more pointed description: spending through the tax code.
The tax system is ...equivalent to a collection of individual mandates, like the one in the Obama health-care law, with penalties for Americans who fail to buy insurance. For many people, that’s how our system works. You and your neighbor might have the same income, but if, unlike your neighbor, you fail to have a mortgage or buy as much health insurance, then you have to pay higher taxes.
You may feel very differently about tax deductions, government handouts and mandates backed by penalties. Economically, though, they are identical. They yield the same outcomes and provide the same incentives.

Insidious Mechanism

...Unlike typical government spending, tax expenditures aren’t reauthorized each year by Congress, so they have immense staying power. Because they aren’t as visible as outright spending, they aren’t subject to the scrutiny of campaigns to pare back waste or assess effectiveness.
Indeed, spending through the tax code is so politically stealthy that it has won over enemies of government largesse, such as Grover Norquist... It’s a tribute to our psychological biases that getting a subsidy through the tax system is treated so differently from receiving a government check...
The result: Even as many areas of government spending have been cut to the bone, our tax code remains larded up with expenditures that cost taxpayers $1.3 trillion every year. According to the nonpartisan Tax Policy Center, the biggest tax expenditures apply to employer-provided health insurance, pension contributions and mortgages.
Popular as such tax breaks may be, they differ from typical government spending in that they give bigger subsidies to wealthier families. Imagine if we mailed checks to all homeowners to help them pay their mortgages. Would you support giving millionaires with mansions 25 times more than the typical family? That’s effectively what we do: Middle-class families get an average benefit from the mortgage interest deduction of $139, while families in the top 1 percent get $3,752.
Taken together, individual income tax expenditures are the equivalent of sending $686 each year to those in the bottom fifth of the income distribution, $3,175 to those in the middle fifth, and $30,714 to those in the upper fifth. The average member of the top 1 percent gets nearly a quarter of a million dollars a year...
The rich get such big subsidies for three reasons. First, they spend more on the things the tax system favors, such as homes and health care. Second, they are subject to higher tax rates, so they get more benefit from each dollar of deductions. Finally, they’re rich enough to take full advantage of their deductions. The poor typically have too little income to itemize, while many families in the upper middle class find themselves siphoned off into a separate tax system known as the alternative minimum tax, which allows fewer deductions.

Honest Discussion

...Here’s our proposal: Let’s 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. Doing so would help us answer crucial questions, such as whether we get more bang for our buck by subsidizing homeownership or by spending more on schools. There’s one more payoff to getting rid of the myriad breaks hidden in our byzantine tax code: It will be a lot easier to get your taxes done before midnight.

Mitt Romney says he wants to reduce tax expenditures and reduce tax rates although he has not specified any significant deductions and loopholes that he would close because most of them are popular.  Although some analysts such as the Tax Policy Center judged that Romney's unsubstantiated goal to broaden the tax base would raise taxes on the middle class, that could arguably be good for economic growth:

Conservatives worry a lot that high taxes discourage growth. Liberals tend to downplay this. One way they downplay it is by noting that in addition to the incentive effect (higher rates give you less reason to work) there's an income effect (less money in your pocket gives you more reason to work). The genius of the Romney reform is that from a labor-supply viewpoint it pushes on both levers.

Thanks to the lower marginal tax rates, under Romney's plan everyone would face lower taxes on the next dollar of income he earns. That's a stronger incentive to work. But thanks to the elimination of deductions, most middle class families would see their total tax bill go up. Those lower after-tax incomes also create a stronger incentive to work. It's a double-whammy, staying revenue-neutral while turning the tax code into a much more work-friendly document.