Income tax breaks now cost the U.S. government as much revenue as the personal income tax raises, and that has to end, tax experts say.

Alan Greenspan and Martin Feldstein are two famous economists who attacked the complexity of the U.S. income tax system at a recent hearing on tax policy and the federal budget deficit that was organized by the Senate Finance Committee fiscal responsibility subcommittee.

Feldstein argued that many “special features” in the U.S. tax code are substitutes for direct government spending and are wasteful in the same way that direct government spending Cowwould be.

Feldstein called for limiting the revenue loss from the itemized deductions and the exclusion of employer payments for health insurance to 2% of each individual’s adjusted gross income.

The 2% cap “would raise more than $275 billion at current income levels and more than $3 trillion over the next decade,” Feldstein said.

The tax expenditure limit should not apply to the tax rules that encourage saving and investment, such as the deduction for individual retirement account (IRA) contributions, the exclusion of the earnings in IRA and 401(k) accounts, and the lower tax rate on capital gains, Feldstein said.

“Although these features are counted as ‘tax expenditures’ in the official government analyses, they have favorable effects on saving and investment and should therefore be preserved without limits,” Feldstein said.

Even imposing a 5% cap, rather than a 2% cap, would generate more than $100 billion of additional annual revenue at the current income levels, Feldstein said.

Another witness, Edward Kleinbard, a law professor at the Univesity of Southern California and a former chief of staff at the congressional Joint Committee on Taxation, said Congress must take care to “boil the frog slowly” when changing the tax code.

The group health tax subsidy, for example, is so interwoven with the health care delivery system that Congress must move carefully when unwinding it, Kleinbard said.

But Congress must unwind the subsidy, and overhaul the health care system as a whole, Kleinbard said.

“The United States today spends much more on health care per capita than does any other developed economy in the world,” Kleinbard said. “If the United States were to expend per capita what Norway (the second place country) does on health care, our aggregate health care spending (public and private) would immediately decline by some $800 billion [per] year.”

Kleinbard also called for phasing in elimination of the home mortgage interest deduction and other personal itemized deductions.

The deductions “invariably are described as ‘sacred cows,’” Kleinbard said. “But they are sacred cows that we can no longer afford to maintain. Either we eliminate these sacred cows, or we allow them to stampede over us…. Our only practical hope is to round up and eliminate all these tax sacred cows at once.”

The United States has very low taxes this year by international norms and its own norms, and that means there is room to bring in more tax revenue without hurting the economy, Kleinbard said.

Kleinbard’s tax reform “base case” includes individual tax breaks that were created between 2001 and 2003 and renewed in 2010 to lapse at the end of 2012.

Congress also should “restore the estate and gift taxes to their 2009 levels, preferably as of Jan. 1, 2012,” Kleinbard said.

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