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New U.S. $20 bills a printed in Washington in October of 2006. (J. SCOTT APPLEWHITE/AP)
New U.S. $20 bills a printed in Washington in October of 2006. (J. SCOTT APPLEWHITE/AP)

Tax the rich to bail out Uncle Sam? It’s not as simple as it seems Add to ...

If the showdown over America’s finances is a war, then this is the hidden battle.

To fix the nation’s fiscal mess, politicians are eyeing an area Americans consider sacrosanct: their ability to pay fewer taxes thanks to a smorgasbord of deductions, credits and exclusions.

President Barack Obama met congressional leaders on Friday to start hammering out a deal to avert automatic spending cuts and tax hikes at the start of next year (the so-called fiscal cliff). But in a debate that often focuses on raising tax rates or cutting social programs, tax breaks are a quiet giant, so much so that one political scientist dubbed them “the submerged state.”

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These provisions are very large – in 2012, the biggest ones will total more than $800-billion (U.S.), greater than the spending on defence or Medicare – and very popular. “They’ve been sacred cows,” says Eric Toder, co-director of the non-partisan Tax Policy Center, although “they’re becoming a little less sacred now.”

For the majority of economists and policy wonks, these tax breaks are simply disguised spending – indeed, the technical name for them is “tax expenditures.” They include the fact that Americans do not pay taxes on the value of the health insurance they receive from their employers and the ability to deduct the interest homeowners pay on their mortgages.

These measures – which now number more than 200 – fill a particular niche in America’s two-party politics. “We get to have our cake and eat it too,” says Christopher Howard, a political scientist at the College of William and Mary in Virginia, who wrote a book about such popular loopholes. “Republicans get to say, ‘Look, we’ve cut taxes,’ and Democrats get to say, ‘Look, we’ve created more help.’”

(Canada is no slouch in this department. The breaks it grants related to income taxes are nearly as large, as a percentage of economic output, as those in the United States, according to a 2010 report from the Organization for Economic Co-operation and Development).

Now, the U.S. financial predicament is pushing Republicans and Democrats to take another look at these tax breaks. In a bitterly divided political landscape, they are considered potential ground for compromise: Curbing or eliminating them would allow the government to raise revenue (a basic requirement from Democrats) in a way that does not increase actual tax rates (a fundamental demand from Republicans).

In the waning days of the presidential campaign, Republican Mitt Romney floated just such an idea, which would have capped individual deductions at a certain ceiling.

Of course, such a change would only be one step toward resolving the U.S. fiscal conundrum. And any move to eliminate these perks would enrage powerful lobbies and, potentially, ordinary people too.

“When something affects tens of millions of taxpayers, it ceases to be a ‘special interest,’” says John Buckley, a law professor at Georgetown University who worked in Congress on tax legislation for more than 30 years. “The political pain here is grossly underestimated.”

Joanna Slater is The Globe and Mail’s New York bureau chief.

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