If our beloved> Washington politicians ever get serious about tax reform, one of the first priorities should be stripping out "targeted" tax breaks. They are bad public policy for two reasons.
First, they are used by politicians and bureaucrats to micromanage the economy by picking winners and losers. It's increasingly obvious that the so-called experts in Washington are not smart enough to be given this power.
Second, targeted tax breaks encourage governmental corruption because those who benefit are willing to pay whoever they need to pay to get the goodies.
But let's get specific. I quickly came up with five sterling examples of dumb tax breaks that need to be swept out (there are many, many more, but I'm only allowed so many words). Prepare to get mad, because your ox might be gored.
Exemption for Forgiven Home Mortgage Debt
Say you take out a mortgage to buy a primary residence. You later default, and the lender takes the property back after forgiving part of the mortgage balance. Ordinarily, forgiven debt --including forgiven home mortgage debt -- counts as taxable income unless you are bankrupt or insolvent, in which case the forgiven debt is tax-free. Fair enough. But in 2007, Congress enacted a special provision that allows tax-free treatment for up to $2 million of forgiven home mortgage debt -- even if you are not bankrupt or insolvent. Because the $2 million limit is so high and because you don't have to be bankrupt or insolvent, even millionaires can qualify for this ill-conceived tax subsidy. Nice work Congress.
Credits for Energy-Efficient Home Improvements
On my 2010 return, I claimed a $1,500 tax credit for installing energy-efficient windows in my home (the credit has since been reduced to $500). The $1,500 was a nice bonus for me, but it sure wasn't good public policy. Why should other taxpayers be subsidizing my home improvements? Answer: they shouldn't.
It gets worse. If you install more exotic (and expensive) energy-efficient home improvements like a solar water heating system or a geothermal heat pump, you can collect a tax credit equal to 30% of the cost. There's no limit on the credit amount, there's no phase-out rule for high-income taxpayers and vacation homes are eligible. So middle-income taxpayers are now subsidizing home improvements for billionaires' vacation homes in Aspen. Do you see anything wrong with this picture?
Credit for Burying Hot Air
Legislation enacted in 2008 created a new tax credit for capturing carbon dioxide from industrial facilities and then storing it in "secure geological formations" or using it as a tertiary injectant in enhanced oil and gas recovery projects; tertiary injectants are pumped into the ground to force out more oil and gas. So this is literally a tax credit for capturing and disposing of hot air, which explains why it made sense to Congress.
Percentage Depletion for Oil and Gas Wells
Eligible oil and gas producers are allowed to deduct 15% of revenues as a so-called percentage depletion write-off. Here's the problem: you should only be able to deduct things that actually cost you money. The 15% depletion write-off is based on revenue rather than expenses. In other words, the deduction has nothing to do with economic reality. While I'm all for energy independence and expanding domestic oil and gas production, it's time to give the heave-ho to this longstanding but ill-conceived tax break.
Deduction for Domestic Production Activities
The quick history of this break goes like this: First Congress considered simply lowering the corporate income tax rate to stimulate domestic job formation. But that idea was too straightforward to allow for micromanagement, so Congress thought about inventing a targeted tax break for manufacturers. Sensing blood in the water, the lobbyists assaulted Washington in full force. The end result was the so-called "domestic production activities deduction." With dazzling complexity, it gives big write-offs to, among others, producers of films and sound recordings, software developers, construction contractors, architects, farmers, and even honest-to-gosh manufacturers, too. However, if you run a restaurant, your domestic production activity was deemed unworthy of the deduction. Conclusion: It's all about the lobbyists, baby.
Some people, including me, advocate for lower taxes. Others favor higher taxes. Whichever direction we choose, we need to go there with a simpler and fairer system. If we choose lower taxes, make it happen with across-the-board rate cuts that benefit everyone who pays taxes. Let the economic chips fall where they may. If we choose higher taxes, make it happen with across-the-board rate increases that spread the pain as widely as possible, with no exceptions for politically favored constituencies. Keep these thoughts in mind, because the winds of change are blowing, and the 2012 election will be here before you know it.