Financial Transparency Coalition

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President Obama’s State of the Union address this week included an impassioned argument for a “balanced approach” to deficit reduction; meaning that spending cuts should be coupled with revenue increases. Many Republicans disagree—arguing we should cut spending while leaving taxes at their current rates.

The bright line between taxes and spending is, in fact, not so bright. One obvious example is tax expenditures—government spending through the tax code, also called loopholes. In some ways tax expenditures are good; for example, they can be used as incentives to encourage corporate and private behavior that provides a social benefit. On the other hand, these expenditures both lower government revenue and can skew the horizontal and vertical equity of our tax system. For example, corporate loopholes can result in dramatically different effective corporate rates for nearly identical companies. Similarly, they allow some very wealthy American families to pay lower tax rates than their counterparts in the middle class.

Last week Senator Bernie Sanders (I-Vermont) introduced the Corporate Tax Fairness Act, a proposal to cut one of the U.S.’s tax expenditures. The bill would raise an estimated yearly $60 billion by ending “deferral,” which allows U.S. corporations to indefinitely defer payment of overseas earnings. This loophole creates two incentives: (1) for corporations to shift profits overseas to tax havens using transfer pricing, and (2) for those corporations to hold large deposits of untaxed cash sitting in bank accounts overseas.

To see why this option for raising revenue is so appealing, it helps to compare it to some of the other revenue-generating, tax-expenditure-eliminating options on the table. As I hinted at, the significance of these expenditures is not only how much money they raise, but also the kind of behavior they incentivize, their effect on the economy, and their distributional effects. To illustrate these issues, I’ll compare the Corporate Tax Fairness Act, which would eliminate corporate deferrals, to three other, similar in scope, eliminations on the table: (1) the mortgage interest deduction (would raise $98 billion); (2) the charitable donation deduction ($43 billion); and (3) the health insurance deduction ($184 billion).

Let’s start with incentives and behavior. As I noted previously, the deferral loophole has one major incentive: for U.S. multinationals to transfer and hold their revenues overseas. From an economic and policy perspective in the United States, this is a bad incentive. Even if they were just holding the cash in the bank (which they’re not), we’d rather multinationals held their money at home than abroad. For the others, the tax code incentive is pretty good. To some extent, the mortgage interest deduction encourages homeownership, the charitable donation deduction encourages Americans to donate money to non-profits, and the health insurance deduction encourages employers to provide their employees with health insurance.

Each of these incentives, in turn, has an effect on the economy. Again, deferral encourages corporations to shift profits abroad, which is an economic drag. Now, to be clear, ending corporate deferral is not going to encourage multinationals to suddenly bring home the billions in cash they hold overseas. But it does remove the incentive for them to engage in abusive transfer pricing. The other economic effect will result from raising corporate taxes, which may negatively affect corporate and shareholder profits. Some of these effects may trickle down to employees, which would have a negative effect on aggregate demand (that is, economic growth).

The effects of the other proposed tax expenditure cuts are arguably worse for the economy. Cutting back the mortgage deduction would dampen demand for our already depressed housing market and bring home values down, slowing a recovery that is just gaining steam. It would also lower household after-tax income. Similarly, some have estimated that cutting the charitable donation deduction would reduce charitable giving by $34 billion. Those non-profits would then cut jobs and salaries, which would reduce household income, and have a negative effect on aggregate demand. The economic effects of the health insurance deduction are a little more complicated—while they certainly lead to lower deductibles and more coverage, it has also lead to higher health care costs.

Finally, each of these economic effects has distributional effects that are important. For example, while eliminating either the Corporate Tax Fairness Act or the charitable contribution deduction would lower net income, in the first case it would lower net profits for multinationals—much of which is disbursed to wealthy shareholders. In the latter it would reduce the income of charities, who use their earnings for employees’ salaries and philanthropy, in many cases for society’s marginalized (of course stunning exceptions exist).  On the other hand, eliminating the mortgage interest deduction would actually be fairly progressive; on average, households earning less than $40,000 would see their tax bills rise by about $110, those earning $125,000 to $250,000, lose about $2,700; and those with incomes above $250,000 would owe about $5,400 more. As it exists, the tax-free health insurance contribution is similarly regressive—a family in the 50 percent tax bracket who gets an employer plan of $20,000 gets twice the subsidy as someone in the 25 percent bracket with the same plan.

None of this is cut and dry. There are positive and negative aspects to each of these eliminations. Likewise, none of these options alone would fix our budget problems. Far from it, actually. On balance, though, the Corproate Tax Fairness Act would eliminate a incentive that encourages multinationals to shift and hold profits overseas and would have a progressive economic impact, rather than disproportionally burdening the middle class. On balance, from the perspective of incentives, economics, and distribution, the Corporate Tax Fairness Act is a no-brainer.

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