Now's the Time to Tackle Tax Reform

Remember all the calls for tax reform and cries for reining in ballooning federal deficits? They are fading into the woodwork of all those Congressional chambers that have heard it all before. After four years of trillion-dollar deficits, the Congressional Budget Office is forecasting less than a $650 billion deficit.

Further, the major drivers of the deficit - health care and, to a much lesser extent, Social Security - have stabilized their finances. Last week's annual trustee report on Medicare extended the projected depletion date of the hospital trust fund by two years from the 2012 report to 2026. A companion report on Social Security said the program's current surplus would disappear by 2033 - the same year as in last year's report.

[Read: Social Security Needs to Prepare for Aging Americans.]

The bipartisan dysfunction in Congress appears to have survived last fall's elections, so backing away from another fiscal fandango is not surprising. Immigration reform histrionics beckon, and there seems to always be room for yet another House vote to repeal the Affordable Care Act.

This relative budget lull, however, would be the perfect time to get serious about tax reforms that both parties have expressed interest in tackling. Doing so when the fiscal heat is off - at least in relative terms - would be an act of management leadership that could restore faith in the governing process.

Federal tax breaks, or tax expenditure items as they're called, total more than $1 trillion a year in reduced federal tax revenues. By attacking some of these tax breaks, Democrats could find some protective ground against entitlement cuts. Likewise, reduced tax breaks would permit Republicans to achieve lower individual and corporate tax rates. Done right, federal revenues would increase and further narrow the budget gap.

[Read: 4 Reasons Gen X Will Struggle in Retirement.]

The CBO recently updated its assessment, done in partnership with the Congressional Joint Committee on Taxation, of the value of tax entitlements primarily benefiting consumers. Its top 10 consumer tax breaks totaled about $925 billion a year.

These 10 items "will account for roughly two-thirds of the total budgetary effects of all tax expenditures in fiscal year 2013," the CBO said. "Together, those 10 tax expenditures are estimated to total more than $900 billion, or 5.7 percent of gross domestic product in fiscal year 2013 and are projected to amount to nearly $12 trillion, or 5.4 percent of GDP, over the 2014-2023 period."

The scale of the tax breaks is enormous, equaling a third of all federal spending and exceeding the amount of net federal expenses for Social Security, Medicare or defense.

Two of the 10 items are the earned income and child tax credits. Their benefits flow primarily to low- and moderate-income taxpayers and even to those who make too little money to owe any federal income taxes. However, the CBO report noted that most of the individual breaks are for higher-income taxpayers.

[See: Top 10 Corporate Tax Breaks.]

"CBO estimates that more than 90 percent of the benefits of reduced tax rates on capital gains and dividends will accrue to households in the highest income quintile in 2013, with almost 70 percent going to households in the top percentile," the report said. "Those benefits will equal 2 percent of after-tax income for the highest quintile and 5 percent of after-tax income for households in the top percentile."

Here is the CBO's list of the top 10 individual tax breaks and their annual value this year:

Budget Impact of 10 Largest Individual Tax Breaks

Item

2013 Impact (in $billions)

Employer Health Insurance

248

Tax Rates on Capital Gains and Dividends

161

Retirement Account Contributions and Earnings

137

State and Local Taxes

77

Mortgage Interest

70

Earned Income Tax Credit

61

Child Tax Credit

57

Capital Gains Excluded from Estate Taxes

43

Charitable Contributions

39

Social Security and Railroad Retirement Benefits

33

Total of Top 10 Items

926

Source: Congressional Budget Office, Joint Committee on Taxation