The National Commission on Fiscal Responsibility and Reform is in a pickle. We can expect Republican members of the Commission to push for cuts in government spending but no new taxes, and Democratic members to argue that tax increases are necessary. With a supermajority required to approve any recommendation, what hope is there of success?



The best hope for bipartisan consensus lies in targeting the $1.2 trillion a year in hidden government spending embedded in the Tax Code in the form of "tax expenditures." These programs are styled as tax savings, but really function as replacements for explicit government spending. Some make sense, but a great many are poorly targeted and would never pass Congress if presented as an outright spending proposal.



Unfortunately, some of the most popular of these tax breaks - in particular, political "sacred cows" like the home mortgage interest deduction, the charitable contribution deduction and the deduction for state and local taxes - are incredibly expensive and give the country very poor returns relative to their cost. Everyone likes these tax breaks, but in light of the long-term fiscal crisis facing the country, we must choose: we can maintain our herd of hideously expensive tax sacred cows, or we can sacrifice them and set the country on the path to fiscal health.



Today the government spends more through tax expenditures than it collects from the personal income tax, and spends twice as much through the Tax Code as it does through explicit discretionary spending programs. Unlike explicit spending, tax expenditures show up in the budget process simply as reduced tax revenues. In reality the tax revenues are there, borne by taxpayers not eligible for the subsidy, and spent on those who do qualify. It's as if the government actually collected roughly twice as much in personal income taxes as it actually does, but then spent all those extra revenues on programs that today are invisible as a matter of budget presentation or debate.



The reason to focus on tax expenditures is that we have little choice. Cutting traditional spending programs cannot by itself address the fiscal gap in the second half of this decade. For 2007, total non-defense discretionary spending (for example, spending on highways, housing, education and national parks) amounted to only 18 percent of federal government outlays. Cutting Social Security benefits or government spending on healthcare could make a much larger impact, especially the further out you take the projections. But in light of citizens' reliance on existing programs in planning their futures, the aging of America's population (and with it the increase in demands for these programs), and the long time lag before incremental changes materially affect budget numbers, it is improbable that even remotely feasible changes in Social Security or healthcare policies could by themselves address our deficit problem over the next decade.



From the other direction, the fiscal gap also cannot be addressed solely by taxing the rich. To do so would require that the top income tax rate jump from 35 percent to 75 percent or more - levels that haven't been seen in over 40 years. In light of the increasing income inequality in the United States, there's a good case to be made for somewhat higher marginal rates on high-income Americans, but there just aren't enough rich individuals to fill the fiscal gap by themselves.



By necessity, then, any plausible plan to set this country on a sustainable budget path will require higher tax revenues, borne by the majority of Americans. This need not be dismissed as irresponsible. The United States currently is a low-tax country. The OECD calculates that the aggregate tax burden in the United States (federal, state and local) in 2007 was the fourth-lowest as a share of gross domestic product among the organization's 33 members, comprising most of the world's large economies.



By making some judicious adjustments to tax rates and targeting tax expenditures, we can meet President Obama's goal of reducing budget deficits to 3 percent or less of GDP in the second half of this decade, and we can shrink the overall handprint of government on the economy. (Longer-term balance requires revisiting the major entitlements programs.) Moreover, we can do so without recourse to new taxes, like a Value Added Tax.



The process would include two elements: first, revert to the tax rate schedule in effect during the Clinton Administration. That will raise the tax rates imposed on affluent Americans in particular, but only to levels that we know from past experience are consistent with a robust economy. Second, eliminate itemized deductions, except possibly those for extraordinary medical expenses (because they do relate to an individual's ability to pay tax).



The largest itemized deductions, those for home mortgage interest, charitable contributions and state and local taxes, are among the most expensive tax subsidies. These three sacred cows alone are projected to cost at least $240 billion for just the coming fiscal year, and that cost will climb as the economy recovers. Only about one-third of tax filers are eligible to claim itemized deductions. And most economists agree that itemized deductions are poorly designed as incentives, for two reasons. One, the subsidies go up as an individual's income increases (because tax deductions are more valuable the higher your maximum tax bracket), and two, they frequently reward acts - much charitable giving, for example - that would have occurred even without the subsidy.



Economists Rosanne Altshuler and colleagues at the Tax Policy Center recently calculated that the changes proposed here would raise more than enough revenue to address the fiscal gap in the second half of this decade. The proposal also would add to the progressivity of the tax system, because itemizers in most cases are higher-income taxpayers. Moreover, the changes would also cause fewer tax-related adverse effects on the economy than would other income tax revenue-raisers of comparable magnitude, such as significant hikes in marginal tax rates at every level.



Of course, it would be inadvisable to go cold turkey on a change as dramatic as the one I propose, because current housing prices and household budgets incorporate the existence of these subsidies. Instead, their elimination should be implemented over a period of several years. That delays the full benefit, but the sooner we begin phasing out much of the synthetic government spending that permeates the Tax Code, the sooner we will reach the goal of sound fiscal policy.



Itemized tax deductions and other tax expenditures routinely are labeled "sacred cows," made politically untouchable by virtue of their great popularity and entrenched political constituencies. But the reality is that, in light of our current unsustainable long-term fiscal path, we really have no choice: it's them or us. Tax expenditures are a $1.2 trillion per year herd of sacred cows that we can no longer afford to keep. Their culling must begin.