The public debate about “tax loopholes” is muddled at least in part because “loopholes” and “tax expenditures” have become intertwined. Both are peculiar terms.
“Loopholes” have a history. Some accounts report the term as originally referring to the narrow slits (larger on the inside and smaller on the outside) cut into castles. They made it possible for defenders to peer out and watch with relative safety, and when necessary, fire arrows or other projectiles to protect the castle. Some loopholes in castles were slightly larger and could be used as an escape when necessary. Other explanations of the origin of the term point to alternative Dutch words meaning “to run” and “to watch”. Others refer to an English term, suggesting “to leap.” A number of references cite poet Andrew Marvell (1621-1678) using loopholes to communicate the ability to evade or squeeze through. Today, loophole is a symbolically rich term that is intended to mean that something unseemly is taking place through such evasion and squeezing.
Are tax expenditures an entirely different matter? The Congressional Budget Act of 1974 (Public Law 93-344) defines tax expenditures as, “…revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability.” That is, in plain English: tax expenditures are lost tax revenues caused by special exceptions to tax laws. By law, a list of “tax expenditures” must be included in the President’s budget in a section titled “Analytical Perspectives,” prepared by the Office of Management and Budget. The list for 2012 includes 173 “tax expenditures (p241 – 251),” which total over one trillion dollars for the fiscal year beginning October 1, 2011. As objective as this may sound, the list and estimates of “cost” is actually quite subjective, because analysts posit the starting point of the tax baseline.
The categories for the 173 “tax expenditures” in the 2012 budget proposal are: national defense, international affairs, general science, space and technology, energy, natural resources and environment, agriculture, commerce and housing, transportation, community and regional development, education, training, employment and social services, health, income security, social security, veterans benefits and services, general purpose fiscal assistance and interest. In an addition, an addendum is included, aid to state and local governments. At some point, a group of legislators considered each one of these ideas useful to achieve a specific policy objective.
Some of these are obvious. The deferral of interest on U. S. savings bonds promotes savings and helps fund the government. The deductibility of mortgage interest on owner-occupied homes facilitates home ownership and encourages home construction, a large segment of the U. S. economy. The deductibility of student-loan interest helps make higher education more accessible.
Other “tax expenditures” are more controversial, such as the deferral of income from controlled foreign corporations under the normal tax method. Law makers gave multinational corporations tax advantages in an attempt to prevent them from relocating outside of the United States.
Reforming such tax laws is difficult, because it would have economic consequences. Each expenditure and loophole must be addressed carefully so as not to produce unwanted economic consequences. Eliminating “tax expenditures” is policy making. Eliminating “loopholes” is a means of administratively cleaning up tax law. Each “tax expenditure” and “loophole” needs to be considered closely. Tax reform, like the devil is, in the details.
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