Tax Breaks Are Not Tax Expenditures


“Though the earth, and all inferior creatures, be common to all men, yet every man has a property in his own person: this no body has any right to but himself. The labour of his body, and the work of his hands, we may say, are properly his. Whatsoever then he removes out of the state that nature hath provided, and left it in, he hath mixed his labour with, and joined to it something that is his own, and thereby makes it his property.” — John Locke, Second Treatise of Government (1690)

What is “spending through the tax code?”  This is an important question in light of the Obama FY 2014 budget proposal finally unveiled last week.  We already know it raises taxes by more than $1 trillion.  Much of this is done by eliminating so-called “tax expenditures.”

Here is how the Joint Committee on Taxation defines a tax expenditure:

Tax expenditures are defined under the Congressional Budget and Impoundment Control Act of 1974 (the “Budget Act”) as “rev­enue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross in­come or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.”

Members of the Left are masters at twisting jargon in this manner, so let’s be careful.  There are certainly inequities in the tax code, but all but one of these categories of tax expenditures are aspects of the tax code that are structured to allow individuals and other entities to retain more of their wealth.  In other words, these purported tax expenditures merely prevent or delay the involuntary transfer of private property to the federal government.  How is that spending?

As I’ve written previously, libertarians and conservatives recognize that private property rights are at the foundation of individual liberty, and that any just government must be dedicated to the Lockean principle of protecting the individual’s right to the fruits of his labor.  Treating an exclusion, exemption, deduction, preferential rate, or deferral of tax liability as government spending presumes that the government has a right to those fruits by default — that we are privileged to retain any such fruits, and the government spends its funds in permitting it.  This confiscatory mindset is foreign to our founding and inconsistent with our nature.

This is not to suggest that all forms and levels of taxation are a violation of our private property rights.  But we have come a long way from respecting property rights when dollars kept in the private sector are considered spent dollars by the government sector.

By far the largest of these tax breaks mislabelled as tax expenditures are for employer-sponsored health insurance and for retirement saving.  According to the Joint Committee on Taxation, these breaks will “cost” the federal government $760.4 billion and $708.6 billion respectively over the next five years.

Capping Your Retirement Plan

It should come as no surprise then that the 401(k), IRA, and other private retirement plans are among the prime targets of the new Obama budget.  One of the President’s great talents is informing you of what you don’t need, and utilizing the instrumentalities of government to make sure that you won’t get it.  This time, you don’t need more than $3 million total or $205,000 per year in retirement.  After all, that is “substantially more than is needed to fund reasonable levels of retirement saving.”  Unfortunately, there is no mention in the budget of what amount of private sector taxation is substantially more than needed to fund reasonable levels of federal government spending.

Most of us do not anticipate saving $3 million for retirement.  That’s beside the point.  What will happen to those industrious and successful individuals who have saved over that much already?  The confiscation process is not clear.  And consider how such a cap would affect the incentives for those producers who strive to retire in that level of comfort.  More importantly, since when is it appropriate for the federal government to tell us how much we need or should be allowed to save for retirement?

This proposal would bring in only $9 billion in revenue to the federal government over the next ten years.  The debt currently stands at over $16 trillion.  This means (a) the supposed savings are so tiny to the point of being irrelevant, (b) they’re planning on eventually coming after your retirement account by lowering the bar significantly to meaningfully raise revenue.

One more crucial point: Tax incentives to save for retirement through a 401(k), 403(b), IRA, etc. do not cause the federal government to lose any revenue.  Any pre-tax or deductible contributions will eventually be distributed, and those distributions will be taxable.  All we’re really talking about here is a deferral of income.  Because the deferral is usually longer than the arbitrary ten-year CBO scoring method, federal budgeting fails to recognize this.

Obamacare Refundable Premium Tax Credits

Of the categories from the 1974 Budget Act, only credits should be referred to as spending through the tax code.  And even within this category, only refundable tax credits are truly tax expenditures.

Here is how the CBO defines a refundable tax credit:

The U.S. tax code contains many preferences that lower or eliminate the amount of taxes owed. Those preferences include deductions, exclusions, and tax credits, which can be either refundable or nonrefundable. Refundable tax credits differ from other preferences in a significant way: Whereas other preferences reduce the amount of taxes owed to the government, refundable credits can result in net payments from the government. Specifically, if the amount of a refundable tax credit exceeds a filer’s tax liability before that credit is applied, the government pays the excess to that person or business.

Let me paraphrase: It’s a straight-up payment to you regardless of your tax liability.  Now that’s spending through the tax code.  According to the CBO, we spent $209 billion on refundable tax credits in 2010, primarily for the Earned Income Tax Credit (EITC) and the Child Tax Credit.

The irony of this all is that President Obama’s signature law is the ultimate actual tax spender.  CBO now estimates the cost of the Obamacare exchange refundable premium tax credits alone will total more than $1 trillion from 2014 through 2022, an increase of $233 billion over the original estimates.

Obamacare and Paying for Health Coverage After-Tax

While Obamacare is designed to boost actual tax expenditures, its second front is to cut down on the tax breaks for health coverage.  Whether it be the health FSA $2,500 cap, the looming excise tax on Cadillac plans, or the higher penalty tax (20%) on non-medical HSA distributions, everything is steering us toward those juicy Obamacare exchange subsidies.

One prime example of this strategy is the Administration’s recent decisions to delay full implementation of the small employer SHOP exchange until 2015 in the 33 states that have not established an exchange.  The likely result is more small employers dropping their health plans and dumping employees onto the exchange.  Carolyn McClanahan at Forbes provides some terrific insight on the practical realities:

If health insurance is purchased through the employer, the premiums are tax deductible for the employee and the employer. If an employee who earns only W2 income purchases their insurance directly, they will not get a tax deduction. This is a back door tax that will raise significant revenue for the government. Individuals may qualify for a nice premium tax credit on one hand, but lose a big part of that tax credit in the form of paying for health insurance with post tax dollars. And we wonder why people don’t trust the government?

One other way Obamacare eliminates so-called tax expenditures is the increase in the threshold to deduct medical expenses from 7.5% to 10% of adjusted gross income.  That means if you’re purchasing coverage on the exchange, you can deduct the costs only if they exceed 10% of your AGI.  When you’re paying for coverage through your employer-sponsored health plan, the full amount is pre-tax through Section 125 of the Internal Revenue Code.

There’s one major exception to this general rule that purchasing health coverage outside of an employer-sponsored plan will cause you to pay more in taxes: HSA contributions.  The amount you contribute to an HSA is an above the line deduction regardless of how it relates to your AGI.  There’s a pretty easy way to close that “tax expenditure.”  Obamacare effectively destroys the high deductible health plan (HDHP) coverage required to to contribute to an HSA.  Don’t expect to see HDHPs on the exchanges.  And don’t expect any tax breaks to pay for your exchange coverage, just the refundable premium tax credits.

The Bottom Line

Ideally we would have a low flat tax or the FairTax, and we would not need or want any tax breaks.  Our system is far from ideal.  The tax breaks that President Obama considers to be tax expenditures are crucial to preserving our right to the fruits of our labor.  Proposals to eliminate tax breaks, especially for retirement and health coverage, exemplify the threats to economic liberty we face as the revenue hawks on the Left continue to scour the tax code for backhanded tax increases.

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