How tax breaks could break tax reform

The government will give you a tax break if you hunt whales.

Or if you’re 65 years old. Or if you’re a policeman who wants to retire early. Or if you donate a painting to a museum.

There are special tax breaks for ministers and veterans and life insurance companies and blind people and gamblers. If you’re robbed or you have huge medical bills or you’re in a shipwreck or you ride your bike to work, you get a tax break.

If lawmakers ever really dive into a tax-code rewrite — and they say they’ll move to it once they’re done with the Affordable Care Act — they will face a barrier that may be insurmountable: legions of tax breaks, each with special-interest constituencies willing to go to the mat to save them.

The code is stuffed with narrowly drawn provisions, benefiting huge numbers of Americans doing a huge number of things. One compendium of the breaks runs 1,100 pages.

The administration and congressional leaders are now working behind closed doors on a tax-reform plan. So far, they’ve mostly stuck to generalities, like the importance of reducing tax rates. On Thursday, they released a statement underscoring their commitment to revamping the code but giving no hint of the trade-offs that will be necessary.

Most of the targeted tax provisions are rarely debated in Congress — the deferral of gain on non-dealer installment sales, anyone? Yet Republicans are promising a top-to-bottom cleaning that will sweep away a huge number of breaks, allowing people to do their taxes on a postcard.

They say it will be easier than dealing with Obamacare, because taxes are much more in their party’s bailiwick, and promise to get legislation to President Donald Trump’s desk by the end of this year.

But most of the lawmakers weren’t around for the last tax overhaul, in 1986, and many longtime tax aides say they are seriously underestimating the degree of difficulty that comes with uprooting hundreds of provisions. Many predict they will have no easier time undoing loopholes that have been in the code for decades than they’ve had rolling back Obamacare.

“Oh my Lord, people come out of the woodwork,” said Dean Zerbe, a former congressional tax aide.

The issue of which exact breaks to kill in the name of reform promises to divide Republicans not by ideology, like the ACA, but by much more parochial concerns. Some provisions are hugely important in some areas and to some industries while, in others, they are meaningless.

Republicans got a preview of that regionalism last month when seven of their colleagues in the House, from New York and New Jersey, joined Democrats in denouncing plans to end a deduction for state and local taxes, an important break in high-tax states. Conversely, blue-state Republicans are unlikely to care as much about, say, Section 1301, which allows farmers to cut their taxes by averaging their incomes over several years.

Party leaders plan to present a proposal to their colleagues in September, when rank-and-file lawmakers will have to decide whether they’re willing to stick it to some people in order to achieve a broader reform. Republicans are relying on ridding the tax code of special breaks to help finance an overhaul.

The push comes as the number of targeted breaks has grown to more than 250, according to official tallies.

Some benefit a large swath of the population, such as the exclusion for companies that provide their workers with health insurance. One of 14 health-related breaks in the code, the provision will cost $165 billion this year, more than most federal agencies’ annual budgets. The cost of those provisions grows by an average of 7.5 percent annually, taking account of inflation.

Other breaks are old-fashioned earmarks, like one allowing Alaskan whaling captains to deduct $10,000 worth of boats, weapons and gear by calling them a charitable contribution.

Though lawmakers bemoan a tax code that picks winners and losers, they’ve been doing just that for years, singling out favored groups for special treatment.

A provision added in 2002 allows grade-school teachers (but not pre-K or college professors) to write off up to $250 in job-related expenses. Other people can only write those off to the extent their deductions total more than 2 percent of their adjusted gross income.

"Obviously, no one wants to come out and say they don’t like teachers," said Libin Zhang, a tax lawyer. "But why can’t nurses get this? Or firefighters?"

Professors — along with university presidents, football coaches and other college employees — have their own goody in the code, thanks to a 1984 law stipulating they don’t have to pay taxes on the free tuition their schools offer their children. The IRS would normally consider that tantamount to income, and therefore taxable.

Astronauts who die on space missions get a cut rate on the estate tax, which applies to assets worth more than $11 million. Foreign gamblers have their own loophole, on winnings from "a legal wagering transaction initiated outside the United States in a parimutuel pool with respect to a live horse race or dog race in the United States."

Still, even though they’re caricatured as special-interest breaks, many of the narrow provisions are for average people doing mostly average things.

There’s a $13,460 tax credit for adopting a child. The blind and the elderly get a $1,550 break. Section 165 of the code allows people to write off losses from “fire, storm, shipwreck or other casualty, or from theft.” In 2014, Congress created special tax-favored savings accounts for the disabled.

“Congress in the past has understood that there are a lot of situations out there and you want to make accommodations for people’s situations,” said Jim Hines, a University of Michigan economist who says lawmakers’ criticism of the tax code is overblown. He calls the code "nuanced."

“Of course, there are dumb things in the tax code,” he said, “but a lot of those things are there for good reasons.”

Congress has had an easy time expanding the breaks. In 2006, for example, lawmakers decided to allow police and firefighters to tap their retirement accounts beginning at the age of 50, without having to pay the 10 percent penalty that other people must pay.

By 2015, the list of people Congress had granted similar treatment had grown to include air traffic controllers, customs and border patrol agents, the police who guard the U.S. Capitol and the Supreme Court, nuclear material couriers and “any diplomatic security special agent of the Department of State.”

Subtracting provisions though has been a struggle.

Zerbe, a former Finance committee aide, recalls trying to crack down on an arcane maneuver wealthy art collectors were using to slash their tax bills. They were “partially” donating artworks to museums, and claiming the charitable deductions that came with them, while still leaving the pieces hanging on their walls at home.

“We had millionaires and billionaires rolling in like oranges telling us how this was going to be the end of the world if they couldn’t keep doing this,” he said.

Back in 2014, when then-House Ways and Means Chairman Dave Camp released his long-awaited tax-reform bill — a plan that used the word “repeal” 404 times — Republicans walked away from the proposal, without even putting it to a vote.

One problem for tax reformers is that many of the biggest provisions that would go furthest towards financing a tax-code rewrite — like the deductions for mortgage interest and charitable contributions — have become all-but-untouchable.

On the other hand, it’s also tough for lawmakers to go after smaller ones, especially those benefiting politically popular groups, because they promise difficult fights over relatively little money. Section 107, for instance, excuses a “minister of the gospel” from paying taxes on the share of her income deemed to be a housing allowance.

Ministers can also use that allowance to take out a mortgage, and deduct the interest, which critics complain amounts to double dipping. But who wants to be seen taking a benefit away from ministers?

So one trick for Republicans will be knowing which provisions are big enough to fight over, when it comes to raising cash, but not so large that they cannot be undone. That’s why Republicans are zeroing in on breaks like the deduction for state and local taxes, and also a long-standing corporate break for interest expenses, both of which could raise $1 trillion.

Yet another fault line in the debate will be over not only which breaks to kill or keep, but also which ones should be revised — and that will open a whole set of other battles over how. Camp’s plan rewrote entire sections of the law, including a 30-page plan revamping a long-standing tax subsidy for low-income housing.

All of that promises to upset a whole lot of people, which is why some are discounting the likelihood of a touch-every-section tax overhaul.

With only two votes to spare in the Senate, a fractious caucus in the House and time already running short, many predict Republicans will be forced to settle for something more narrow, like a tax cut that’s partially paid for, in order to reduce the number of losers to a more doable level.

“Based upon how much of the year we have left, you aren’t going to see a comprehensive tax-reform bill,” said Rick Grafmeyer, a former congressional aide and partner at Capitol Tax Partners, LLP. “They may go after some provisions, but it will be handfuls versus hundreds.”

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