Tax Reformers Must Separate the “Good” Loopholes from the Bad

September 30, 2013

Tax Reformers Must Separate the “Good” Loopholes from the Bad

Some Tax Provisions Better for Economic Growth than Others

Washington, D.C., September 30, 2013—Tax reformers in Congress have plans to eliminate a long list of loopholes as a way of cutting tax rates without adding to the deficit. They will need to choose their targets carefully, however, as some of the credits and deductions on the chopping block are actually sound policies that contribute to overall economic growth, according to a new study by the Tax Foundation.

Exchanging some provisions for lower rates would be pro-growth and could pay for dramatic reductions in income tax rates. In the case of some other tax provisions, however—notably those that affect the cost of capital—dropping them in return for lower rates would slow growth and collect much less revenue than expected. Many so-called tax expenditures are not special favors to privileged groups but provisions that belong in the tax code because they correct biases against savings and investment.

“In a conventional estimate, which disregards growth effects, it appears that taking a machete to tax expenditures would produce a huge revenue gain,” said Tax Foundation Fellow Michael Schuyler. “A dynamic analysis that accounts for growth effects, however, tells a different story.”

The Tax Foundation’s Taxes and Growth Model predicts that the real-world consequences of indiscriminately slashing away at the tax expenditure list in return for lower rates would be fewer jobs, lower incomes, and less federal revenue. The equivalent rate cuts, even though quite large, do not guarantee a more prosperous economy.

“The most damaging provisions to eliminate, according to the Taxes and Growth Model, would be those that correct the tax system’s penalties against saving and investment,” said Schuyler. “On the other hand, if one is careful which provisions are eliminated, base broadening could be traded successfully for lower rates and faster growth.”

Tax Foundation Fiscal Fact No. 396 “The Effects of Terminating Tax Expenditures and Cutting Individual Income Tax Rates,” by Michael Schuyler is available online. To schedule an interview, please contact Tax Foundation Communications Manager Richard Morrison at 202-464-5102 or morrison@taxfoundation.org.

The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state, and local levels since 1937.

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