Your Favorite Tax Break Isn’t as Great as You Think

Tax specialists of different political leanings are in surprising agreement about the poor design of top breaks

By Laura Saunders of The WSJ. Excerpts:

"none of these beloved tax breaks rates higher than a B-minus, according to an informal survey of specialists at the Tax Foundation, the Tax Policy Center and the Committee for a Responsible Federal Budget. We asked them to grade the breaks for cost effectiveness and averaged the results."

"When it comes to the federal budget, these tax breaks matter because their forgone revenue comes to about $1.3 trillion annually, according to the Tax Foundation. That’s almost as much as the individual income tax raises"

There’s surprising agreement among tax specialists of different political leanings about the poor design of top breaks. They even agree about some fixes—unrealistic as these may be. Here are their thoughts.

Employer-provided health insurance and medical care. Employers embraced this break during World War II to circumvent wage controls. Now it’s a behemoth, costing $228 billion annually.

Critics give this break a D-plus, saying it helps drive up health-care costs, encourages overconsumption of medical care and impedes a market for individual insurance. Some workers don’t switch jobs because of health coverage.

Mr. Goldwein suggests replacing the current benefit with a tax credit—a fixed-dollar offset for each taxpayer. Initially it would lose the same revenue as the current break, but then grow more slowly than inflation.

Capital gains. The lower rate for long-term capital gains reaps praise for lessening double taxation of corporate profits and encouraging investment.

Critics say the benefit goes mostly to the top 1% and it’s an engine for tax shelters. The capital-gains exemption at death—the “step up”—prompts investors to refrain from selling. Grade: B-minus.

Kyle Pomerleau, policy director at the Tax Foundation, wishes taxpayers could get a tax deduction when they invest, but then owe tax on sales at ordinary rates—with no step-up at death. He thinks this would encourage investment and discourage manipulation.

State and local tax deductions. Opinions on these write-offs differ widely. Some experts grade them C-plus because they encourage state and local governments to provide services, while others give them a flat F, saying they unfairly subsidize locales with higher earners and higher taxes, encouraging bloated government. Average grade: D.

Len Burman, a Tax Policy Center economist and former Treasury Department official during the 1986 tax reform, opts for a C+. But even he would repeal them. In his dreams, he’d put the revenue in a federal “rainy day” fund to help states through temporary economic crises.

Mortgage interest deduction. Our experts all gave this break a D. They think it raises house prices, creating a barrier to entry, and encourages people to buy larger houses than they would otherwise.

Possible corrections: Limit the benefit to one home instead of the current two. In addition, encourage lower-income buyers by turning the deduction into a tax credit of, say, 15% of the interest on a mortgage of up to $500,000.

Charitable-donation deduction. This write-off gets a C-plus. While it encourages worthy charitable giving, some experts think it’s a double subsidy because nonprofits don’t pay taxes. The ability to donate appreciated assets, such as stock, without owing capital-gains tax also encourages gaming, critics say.

Several experts would restrict worthy causes to exclude, say, athletic teams or wealthy universities. This would be hard, because worthiness is often the eye of the beholder."