In recent weeks, Gov. Arnold Schwarzenegger, legislative leaders and the Legislative Analyst's Office have called for eliminating what they term "tax loopholes" to help close California's staggering $16 billion budget deficit.
But one person's loophole is another person's legitimate advancement of public policy. This is especially true with those tax credits or deductions that are both broad-based – benefiting large segments of society – and result in a significant societal benefit. Nothing illustrates this better than the deduction for home mortgage interest. This deduction is unquestionably essential for vast numbers of California homeowners who seek to keep their homes.
Is the home mortgage interest deduction a loophole? Speaker Fabian Núñez has suggested as much and, if he and other Democrats in the legislature pursue the elimination of this deduction successfully, it would constitute a $5 billion tax hike affecting 6.8 million taxpayers.
(Of course here is a good spot to interject that such predictions of additional revenue are vastly overblown. Just ask Pete Wilson, who raised taxes in 1991 and managed to lose revenue. We'll save the discussion of the differences between static and dynamic scoring of revenue proposals for another time. For now, we'll just suspend reality and assume that tax increases will actually increase government revenue).
Eliminating the home mortgage interest deduction is simply a bad idea – and the timing of this proposal could not possibly be worse. Have those who floated this idea been on Venus? California is in its worst housing market decline in the last 15 years, and only 25 percent of California families can afford an entry-level home. Eliminating this deduction would be the equivalent of bayoneting the wounded – on your own side.
Well, if we can't touch the home mortgage interest deduction – or other broad-based credits like the child dependent tax credit – are there any tax credits that taxpayer advocates would be willing to put on the table? And if not, why not?
Our adversaries, seeking to appear more reasonable to the public, argue that the failure to put any "loophole" on the table renders us toadies of the rich and powerful who benefit from some of the these credits. They also claim that our intractable position would give us a forever static tax code.
But now is the time to call their bluff. Here's how.
Those of us who represent taxpayers must remember our starting point: specifically, that government is too big, too wasteful and too corrupt to be entrusted with any more money than we give it now. While Senate leader Don Perata pounds the table and says we must have tax increases for education, the bureaucracy continues to spend money as usual, with no effort to prioritize its programs. That "California doesn't have a revenue problem, it has a spending problem" may be a worn-out expression – but only because it is so true.
As to "loopholes," it is simply a matter of law, not just policy, that any elimination of a tax credit is a tax increase and must receive a two-thirds vote of each house. However, for those who complain that fiscal conservatives are inflexible and hard-hearted, we offer this caveat. We would consider the elimination of narrowly based tax credits that are designed solely to benefit a narrow group of beneficiaries and which advance no legitimate public policy if, and only if, this review were completely separate from a discussion of revenue increases. And the only way to accomplish this is to accompany the elimination of these true "loopholes" with broad-based tax reductions to offset the additional revenue.
Two important clarifications. First, tax reductions must be truly broad-based, preferably rate reductions in the personal income tax or sales tax. Second, even a whiff of manipulation with what constitutes an adequate offset should scuttle any deal. Too often we have seen that so-called "revenue neutrality" in the Legislature really means a tax increase – sometimes in the tens of millions of dollars.
The fallout from this strategy should be amusing because it would put the majority party on the defensive. Let them explain why they would not support a tax reduction for average Californians, as opposed to some powerful special interest.
But lest anyone think we are under the influence of the latest recreational pharmaceutical, we doubt that the Democrats are truly interested in a good-faith effort to review California's tax code in order to eliminate "loopholes" for any reason other than to extract more revenue from businesses and citizens. For that reason, we will continue to oppose the elimination of any tax credit. Because even if some tax credits actually deserve the label of "loophole," government simply does not need more money.