Patching "Tax Loopholes" Poses Its Own Problems

Change too much and you could deter investment and hurt those who planned according to the rules

As the U.S. approaches the fiscal cliff on Jan. 1, closing some of the tax loopholes that cost the Treasury $1.3 trillion a year is emerging as a seemingly easy way to end the impasse over budget reform. House Speaker John Boehner favors broadening the tax base to generate more revenue without raising rates. President Barack Obama, while continuing to demand higher rates on top incomes, says limiting the use of loopholes for the wealthy could be part of the solution.

Loopholes are woven into the fabric of daily life: the home mortgage interest deduction, the favorable tax treatment for investment income, the break that leads so much of health insurance to be provided by employers. Some benefit the rich; others the poor. Some enhance growth; others, not so much.

Tightening them up has potential, but done wrong it could cause more problems than it solves. A botched spackling job could hurt the poor and the middle class and also remove incentives for businesses to invest and grow—without producing a lot of revenue.