The thousands of tax loopholes that litter the corporate tax code in the United States are frequent targets of criticism from both Democrats and Republicans.
Outgoing Republican Senator Tom Coburn released a 300-page report this month denouncing the “complicated mess” that is the federal tax code. Coburn’s swan song described it as riddled with tax breaks benefiting specific groups and companies, creating a “powerful and elaborate system of rewards and punishments” for American taxpayers.
Meanwhile, liberal tax reform group Citizens for Tax Justice decried the one-year extension of a bundle of corporate tax breaks – a measure just passed by the House and Senate, and expected to be signed by the president – as wasteful, unfair and ineffective.
But if railing against corporate tax breaks is a rare area of bipartisan consensus, then why is the tax extender bill one of the few things a lame-duck Congress was able to agree on? And why are these tax breaks — many of which were designed to be temporary — enduring features of tax policy? In fact, despite their apparent unpopularity, tax loopholes generate their own distinctive type of politics that protects them from repeal, no matter how wasteful or frivolous they may be.
Tax break and spend?
Tax loopholes are provisions written into the code that reduce the amount of money a specific type of taxpayer would otherwise have to pay. It could mean offering a special exemption, a deduction, a credit against taxes owed or some other type of write-off. Tax analysts call these provisions “tax expenditures” because, by reducing the amount of revenue that flows into public coffers, they amount to spending.
Some corporate tax expenditures apply to many businesses. For instance, the expensive “accelerated depreciation” break allows companies to deduct the cost of new capital investments from their taxable income more quickly than the value of the asset actually declines. Other corporate tax expenditures, like some of those highlighted in Coburn’s recent report, are narrowly written to apply only to specific sectors or a few companies.
Tax expenditures make up a major share of government spending. The Congressional Budget Office recently estimated that individual and corporate tax expenditures will amount to 8.2% of GDP in fiscal year 2014. This is a major increase from the mid-1970s, when the Treasury Department first began estimating the cost of tax expenditures and when they only amounted to about 5% of GDP. Most of this goes to individual income taxpayers rather than corporate taxpayers. But some breaks in the former category go to businesses that pay taxes through the individual rather than the corporate income tax.
Just on the corporate side, the size and number of tax breaks can have a significant impact on government revenue. For instance, a 2013 analysis by the Government Accountability Office revealed that the cost of such tax expenditures in 2011 was roughly equal to the total amount raised that year in corporate income taxes. For every dollar raised, one was spent on a tax break.
Under the radar
However, while these breaks might be fiscally equivalent to government spending, they are often not treated as such. And herein lies the source of their political attractiveness to legislators on both sides of the aisle.
First, unlike spending programs that are subject to annual review when Congress debates appropriation bills, many corporate tax expenditures are simply adopted as permanent features of the tax code. Since no money has to be explicitly set aside to fund them, tax breaks fly under the radar of policymakers and the public even as they structurally lower the amount of revenue raised.
Even when tax expenditures do come under fire, their design makes them difficult to abolish. Repealing a tax break — or allowing one to expire — causes a tax increase for anyone benefiting from the loophole. As a result, these provisions create constituencies that fiercely advocate for their provision, even while the narrow scope of the loophole shelters it from broader public scrutiny.
Indeed, politicians often deliberately design tax breaks to be temporary in order to minimize their price tag while they are being debated. They know that political pressure will make it difficult to avoid renewing the tax break far into the future.
Finally, the dual nature of tax expenditures, which can be viewed both as tax cuts and as spending on desirable priorities, makes them politically appealing to both parties. For instance, Republicans might promote targeted tax credits for businesses as a way to lower corporate taxes. Democrats, meanwhile, can applaud the same credits as a way of increasing spending on certain types of activities, such as wind-energy production or the hiring of disadvantaged workers.
Given their attractiveness to both parties, we should expect most corporate tax loopholes to stick around. And this has big implications for the prospects for broader corporate tax reform in 2015. Most reform proposals are revenue-neutral, meaning they hinge on abolishing enough loopholes to recoup sufficient revenue so that corporate tax rates can be lowered. The end result of this type of trade would likely be a fairer and less discriminatory tax code. Companies benefiting most from loopholes would pay more than they’re remitting now, but all companies would face lower tax rates and total revenue would be roughly the same.
But if the debate over the tax extenders is any indication, while tax breaks may periodically draw bipartisan fire, their very design creates an uphill battle for Democrats or Republicans who wish to simplify the tax code.