Committee for a Responsible Federal Budget

Spending by Any Other Name Smells as Sweet: Tax Expenditures

Apr 9, 2010 | Taxes

In the complexity that is our tax system, there’s a special group of tax law provisions that significantly change how the regular tax rates affect individual and corporate taxpayers.  Known as tax expenditures, they are changes to the regular rate structure that often have social or economic goals. 

Tax expenditures are about $1 trillion or more annually, approximately equal to all discretionary spending, although it’s difficult to estimate the exact cost because of how these provisions interact with one other. They are not necessarily worse or better than other spending, but, like other expenditures, they add to the complexity of dealing with the government and require higher tax rates (or in terms of the tax code alone, narrow the tax base). 
 
But--unlike other spending—they are counted as if they are negative taxes when in fact they are similar to positive spending.  And, because most are “mandatory,” they are not reviewed regularly.  They are seldom reviewed by the congressional committee that oversees a particular policy area; for example, the mortgage interest deduction provision is reviewed by House Ways and Means and Senate Finance Committees (which oversee tax policy), rather than the authorizing committees that oversee housing policy.
 

Most tax expenditures function as mandatory open-ended spending programs that grow indefinitely. This use of potential revenues—and the higher tax rates required on a smaller tax base--are not weighed against other budget priorities.   They are are also less transparent than mandatory spending, since it is harder to “follow the money” or even estimate their costs. And that lack of transparency allows tax expenditures to be far more regressive than people realize. Although many may seem like “middle-class tax breaks,” they tend to benefit higher-income taxpayers more than any spending program (including Social Security).  They also can be wasteful. Tax expenditures which are designed to encourage behavior (such as homeownership) tend to require a lot of “wasted money,” since they are often very broad. Specifically, they mostly “pay” people to do what they would have done anyway.

Tax expenditure provisions have become increasingly popular to lawmakers. They are designed to encourage or reward economic behavior or provide benefits to citizens, rather than funding spending programs through the annual appropriations process. For example, according to the Joint Committee on Taxation, the February 2009 stimulus bills created 15 new tax expenditures designed to stimulate homeownership, subsidize health insurance coverage for the unemployed, and the “Making Work Pay” tax credit.  Below is a list of the top tax expenditures, according to JCT: 

Top 10 Tax Expenditures, 2009-2013 (in billions) 

Deduction of mortgage interest on owner-occupied homes  $573
Exclusion of employer contributions for health care, health insurance premiums  $568
Exclusion of pension contribution and earnings  $533
Reduced rates of tax on dividends and long-term capital gains  $419
Exclusion of Medicare benefits  $317
Earned income credit  $261
Deduction of state and local taxes  $250
Deduction for charitable contributions  $184
Child tax credit  $160
Exclusion of capital gains at death  $159
 
Critics argue that tax expenditures lack transparency and bypass the normal review channels. And their true costs are largely hidden in the federal budget, as they count as credit against individual or corporate income taxes, meaning they do not show up as a cost to the federal treasury, but effectively lower tax receipts. Using a tax expenditure provision instead of a spending program allows Congress to claim it is cutting taxes, while simultaneously providing a benefit to some group or taxpayers. 
 
There's also some disagreement about what's a tax expenditure.  Is the standard deduction a tax expenditure or a part of the regular tax code?  JCT and the Department of the Treasury (which publishes its estimates of the cost of these provisions in the Analytical Perspectives volume of the president’s budget) list and categorize the provisions differently.