Replacing the Sequester Requires Closing Tax Loopholes

Over the weekend, President Obama and Senate Majority Leader Harry Reid both stated that closing tax loopholes is part of the solution to replacing the coming sequestration of federal spending.

CTJ’s recently updated working paper on tax reform options identifies three categories of reforms that would accomplish this. They include ending tax breaks and loopholes that allow wealthy individuals to shelter their investment income from taxation, ending breaks and loopholes that allow large, profitable corporations to shift their profits offshore to avoid U.S. taxes, and limiting the ability of wealthy individuals to use itemized deductions and exclusions to lower their taxes.

Sequestration: Spending Cuts No One Seems to Want

In 2011, President Obama and Congress agreed to across-the-board sequestration (automatic spending cuts) that they hoped to replace with more targeted, thought-out deficit-reduction measures.

Under the law they enacted, the Budget Control Act of 2011 (the BCA), the sequester was supposed to take effect in the beginning of this year. But the recent deal addressing the “fiscal cliff” replaced the first two months of sequester savings with some arcane accounting gimmicks, so now the sequester begins March 1 if Congress does not act. Between then and the end of the year, it would cut spending by $85 billion. Over a decade, the sequester will cut spending by $1.2 trillion.   

Those cuts are spread evenly across defense and non-defense spending, affecting the programs favored by politicians of every ideological stripe. Lawmakers agree that they do not like the scheduled sequester. Congressional Republican leaders argue that it should be replaced entirely with spending cuts while Democratic leaders in Congress and President Obama insist that revenue increases must be involved.

Revenue Is the Answer

The Center on Budget and Policy Priorities points out that if the sequester is averted with spending cuts and no revenue increases, that will mean that the combination of all the deficit-reduction measures, which began in 2011, would include five times as much in spending cuts as revenue increases. The President is calling for any deficit reduction from this point on to include an equal share of spending cuts and revenue increases. But even this would mean that the combination of all these deficit-reduction measures would include twice as much in spending cuts as revenue increases.

A fair approach would be for Congress to replace the sequester entirely with new revenue. There are several reform options described in CTJ’s working paper that would raise hundreds of billions of dollars over the coming decade.

Some of these reform options could be enacted on their own, like President Obama’s proposal to limit the tax savings of each dollar of deductions and exclusions to 28 cents. Others are more likely to be part of a larger tax reform, like ending the rule allowing corporations to “defer” (not pay) U.S. taxes on their offshore profits or ending the provision in the personal income tax exempting capital gains at death. All of these reforms would end or cut back tax breaks that are hugely beneficial to extremely wealthy families and large corporations but not to low- and middle-income families.