The examples and perspective in this article may not represent a worldwide view of the subject. (March 2015)
Tax expenditures are government revenue losses from tax exclusions, exemptions, deductions, credits, deferrals, and preferential tax rates. They are a counterpart to direct expenditures, in that they both are forms of government spending.
Tax expenditures function as subsidies for certain activities and alter the horizontal and vertical equity of the basic tax system by giving preferential treatment to those activities. For instance, two people who have the same income can have different effective tax rates if one of the tax payers qualifies for certain tax expenditures by owning a home, having children, or receiving employer-provided health care and pension insurance.
The Congressional Budget and Impoundment Control Act of 1974 (CBA) defines tax expenditures as "those revenue losses attributable to provisions of the Federal tax laws which allow a special credit, a preferential rate of tax, or a deferral of tax liability".
The term was coined in 1967 by Stanley S. Surrey, a renowned tax scholar and former Assistant Secretary of the Treasury. Surrey created the term to characterize the political use of tax breaks to enact social policies that would ordinarily be accomplished through direct expenditures. He argued that members of Congress were using tax policy as a "vast subsidy apparatus to reward favored constituencies or subsidize narrow policy areas."
As of fiscal year 2020, the United States Treasury lists over 160 tax expenditures, the majority targeted for private social benefits and services. Since tax expenditures are claimed against a progressive tax code, tax expenditures are worth more to wealthier taxpayers.
Tax expenditures are also common in other countries.
Size of expenditures
The cost of tax expenditures varies from year to year with the level of economic activity, though changes tend to be modest. The Congressional Budget Office (CBO) estimated that U.S. tax expenditures in fiscal year 2019 totaled $1.6 trillion (7.8% of gross domestic product). This was larger than all discretionary spending ($1.3 trillion) and was equal to nearly half of all federal revenue ($3.5 trillion). The CBO has also estimated the size of major tax expenditures on federal receipts as an annual average percent of GDP, for the period of 2016 to 2026. These included, among others:
- Exclusions from income: Employment based health insurance (1.5% GDP) and pension contributions (1.2% GDP)
- Deductions from income: State and local taxes (0.6% GDP) and mortgage interest (0.6% GDP)
- Preferential (lower) tax rates: Capital gains and dividends (0.6% GDP)
- Tax credits: Earned income tax credit (0.3% GDP)
The CBO projected that the top 10 largest tax expenditures would average 6.2% GDP each year on average over the 2016-2026 period. For scale, federal tax receipts averaged around 18% GDP from 1970 to 2016. The CBO analysis does not account for behavioral changes that might occur if the tax policies were changed, so the actual revenue impact would differ from the amounts indicated.
Distribution of benefits
According to the Center on Budget and Policy Priorities (CBPP), tax expenditures disproportionally benefit those with high incomes. The CBPP estimated that the top 1% of U.S. households by income received approximately 17% of the tax expenditure benefits in 2013, while the top 20% received 51%. The top 20% pay 84% of the federal income taxes (not including payroll taxes).
Tax expenditures are distributed unevenly across the income scale. When measured in dollars, much more of the tax expenditures go to higher-income households than to lower-income households. As a percentage of people’s income, tax expenditures are greater for the highest-income and lowest-income households than for households in the middle of the income distribution.
Tax expenditures are considered "off-budget" spending by most economists and budget experts. Tax expenditures are easier to pass through Congress than increases in appropriations spending. They are easily seen as free benefits, when government grants are viewed as giveaways. Unlike direct spending, tax spending must only pass through two committees, the House Ways and Means and Senate Finance. Tax expenditure programs, once in the tax code, do not come up for annual review and can only be removed through tax legislation. Tax expenditure programs are a form of entitlement spending in that every tax payer that qualifies can claim government money. Faricy (2011) demonstrated that when tax expenditures are counted as a type of government spending, Democratic and Republican parties are indistinguishable in annual changes to federal government spending. This study also found that Republicans are more likely to increase tax expenditures when in control of government thereby subsidizing the activities of businesses and the wealthy. Jacob Hacker (2002) shows that the federal subsidization of private health insurance has grown over the years and has made efforts for nationalized health care more difficult. Ellis and Faricy (2011) find that when tax expenditures rise, public opinion adjusts and becomes more liberal to counteract the conservative policies.
Partial exemption of the poor from taxation through reliance on progressive income taxes rather than sales taxes for revenue or tax rebates such as the earned income tax credit loosely correlate with socio-economic mobility in the United States with areas which tax the poor heavily such as the Deep South showing lower mobility than those with generous tax expenditures for the benefit of low income families with children.
- "Policy Basics: Federal Tax Expenditures". Center on Budget and Policy Priorities. December 8, 2020. Archived from the original on October 27, 2021. Retrieved November 10, 2021.
- "The Distribution of Major Tax Expenditures in 2019" (PDF). Congressional Budget Office. October 2021. Archived (PDF) from the original on October 27, 2021. Retrieved November 10, 2021.
- Faricy, Christopher (2011). "The Politics of Social Policy in America: The Causes and Effects of Indirect versus Direct Social spending". The Journal of Politics. 73 (1): 74–83. doi:10.1017/S0022381610000873. S2CID 154998866 – via University of Chicago Press Journals.
- "Tax Expenditures" (PDF). United States Treasury. February 26, 2020.
- Burman, Leonard E; Geissler, Christopher; Toder, Eric J (2008). "How Big Are Total Individual Income Tax Expenditures, and Who Benefits from Them?" (PDF). American Economic Review. 98 (2): 79–83. doi:10.1257/aer.98.2.79. JSTOR 29729999.
- Christian M.A. Valenduc, Hana Polackova Brixi, Zhicheng Li Swift: Tax Expenditures - Shedding Light on Government Spending Through the Tax System: Lessons from Developed and Transition Economies; World Bank Publications, 31 Jan 2003
- Thomas L. Hungerford: Tax Expenditures and the Federal Budget; Congressional Research Service, RL34622, 1 June 2011.
- "A Closer Look at Discretionary Spending" (PDF). Congressional Budget Office. April 2020. Archived (PDF) from the original on June 27, 2021. Retrieved November 10, 2021.
- "Monthly Budget Review: Summary for Fiscal Year 2019" (PDF). Congressional Budget Office. November 7, 2019. Archived (PDF) from the original on September 2, 2021. Retrieved November 10, 2021.
- "The Budget and Economic Outlook: 2016 to 2026" (PDF). Congressional Budget Office. January 2016. p. 101-105. Archived (PDF) from the original on November 10, 2021. Retrieved November 10, 2021.
- Saunders, Laura (2015-04-10). "Top 20% of Earners Pay 84% of Income Tax". Wall Street Journal.
- Howard, Christopher (1997). The Hidden Welfare State: Tax Expenditures and Social Policy in the United States. Princeton: Princeton University Press. ISBN 978-0-691-02646-6.
- Leonard E. Burman: Is the Tax Expenditure Concept Still Relevant?; National Tax Journal, September 2003
- Hacker, Jacob S. (2002). The Divided Welfare State: The Battle over Public and Private Social Benefits in the United States. Cambridge: Cambridge University Press. ISBN 978-0-521-81288-7.
- Ellis, Christopher; Faricy, Christopher (2011). "Social Policy and Public Opinion: How the Ideological Direction of Spending Influences Public Mood". The Journal of Politics. The University of Chicago Press. 73 (4): 1095–1110. doi:10.1017/s0022381611000806 – via JSTOR.
- Hendren, Nathaniel; Patrick Kline; Emmanuel Saez (July 2013). "The Economic Impacts of Tax Expenditures Evidence from Spatial Variation Across the U.S" (PDF). The Equality of Opportunity Project. Archived from the original (Revised draft) on 2013-08-09.
We focus on intergenerational mobility because many tax expenditures are loosely motivated by the goal of expanding opportunities for upward income mobility for low-income families. For example, deductions for education and health costs, progressive federal tax deductions for state income taxes, and tax credits aimed at low-income families such as the Earned Income Tax Credit (EITC) all are targeted toward providing increased resources to low income families with children.Cite journal requires
- David Leonhardt (July 22, 2013). "In Climbing Income Ladder, Location Matters". The New York Times. Retrieved July 22, 2013.
- Surrey, Stanley S. (1974). Pathways to Tax Reform: The Concept of Tax Expenditures. Cambridge, MA: Harvard University Press. ISBN 978-0-674-65789-2.