Democrats have set forth their terms for the next “fiscal cliff” skirmish: They want to match spending cuts with revenue increases by eliminating tax deductions.
“The wealthiest individuals and the biggest corporations shouldn’t be able to take advantage of loopholes and deductions that aren’t available to most Americans,” said President Obama on Saturday. On Sunday’s Face the Nation, House Minority Leader Nancy Pelosi, D-Calif., cited oil subsidies as an example.
On the CNN Sunday show State of the Union, top Senate Democrat Dick Durbin, D-Ill., echoed the president’s remarks and went into yet further detail.
“We forgo about $1.2 trillion a year in the tax code, money that otherwise would go to the government,” he said, citing “these loopholes where people can park their money in some island offshore and not pay taxes.” However, he indicated that Democrats would not touch those deductions which are “near and dear to us individually and to the economy,” such as “the mortgage interest deduction, charitable deductions, [and] deductions for state and local taxes.”
Some policy wonks have come to view those deductions as part of what political scientist Suzanne Mettler calls “the submerged state”: essentially welfare for the wealthy and upper middle class, buried inside the tax code so that it doesn’t look like social spending. Submerged state programs are, in Mettler’s words, “public policies designed in a manner that channels resources to citizens indirectly, through subsidies for private activities, rather than directly through payments or services from government.”
Channeling those resources indirectly is often more palatable than providing direct funding for social spending, because tax cuts are politically popular and don’t immediately register as attempts at redistribution. As a result, both Democrats and Republicans have adopted tax credits and deductions as preferred redistributive instruments.
Liberal commentators such as Evan Soltas favor programs like the Earned Income Tax Credit (EITC), even as an alternative to raising the minimum wage. And whereas presidential candidate Mitt Romney often spoke of his plan to eliminate deductions, he was understandably reluctant to specify which parts of the submerged state he planned to dismantle.
Notably, Obama and Durbin are not saying that they plan to cut programs like the EITC, which is targeted to benefit lower-income households. Instead, they say they would trim those parts of the submerged state which most heavily benefit the rich and upper middle class. According to Mettler, those programs make up the bulk of tax deductions. But among the most egregious policies, she lists one Durbin called “near and dear”: The Home Mortgage Interest Deduction.
“[I]n 2004,” writes Mettler, “69% of the benefits of America’s home mortgage interest deduction were claimed by households with incomes of $100,000 or above—the top 15% of the income distribution. That same group also reaped 55 percent of the benefits emanating from the tax-free status of retirement benefits and 30 percent of those from employer-provided health benefits.”
If Congress does strategically reduce the size of the submerged state, it could surely go some way towards making the United States tax code more progressive. Furthermore, it would make the ways in which the government redistributes wealth less obscure.
But liberals should nonetheless think twice before they hold up the Democrats’ plan as an alternative to pure “austerity.” While eliminating deductions for the wealthy may be, in some ways, the “good kind” of austerity, it is still contractionary fiscal policy: A reduction in the amount of resources being distributed to citizens, in an attempt to trim the deficit and cut down on public debt.
Notably, Democrats are not describing eliminating deductions as a way to fund increased social spending or inject stimulus into other pockets of the economy.
Instead, they’re framing their proposal as the revenue-raising component of a “balanced deal” whose ultimate aim is still to reduce the deficit. So while the Democratic proposal offers up a different (and perhaps more palatable) flavor of austerity, it is nonetheless still austerity. In fact, a spending reduction on its own or combined with tax cuts (such as the Republicans want) would mean less austerity than a comparable spending reduction combined with a revenue increase.