On tax expenditures: Some additional details and a renewed caveat

October 16, 2015

By Matthew E. Milliken
MEMwrites.wordpress.com
Oct. 16, 2015

Author’s note: Things have been a bit disjointed this week — apologies for my erratic posting! MEM

I wanted to follow up on last week’s post about tax deductions with some additional information on the subject.

What is a tax deduction? Actually, the correct term for the concept I discussed in the previous post is tax expenditure, which can take multiple forms. Expenditures encompass deductions, exclusions, and tax credits, which can be either refundable or non-refundable. The Tax Policy Center, a group created by the Urban Institute and the Brookings Institution, has more information in this 2009 briefing.

The Government Accountability Office lists six different types of tax expenditures: exclusions, exemptions, deductions, credits, preferential tax rates and deferrals. (See figure 4 at the bottom of this page.)

• How much do tax expenditures cost the government on an annual basis? The numbers vary from year to year, but in 2014, all tax expenditures cost the U.S. government an estimated $1.4 trillion, according to a 2014 post from the Bipartisan Policy Center which drew on congressional sources.

• How does that compare with other major items in the federal budget? In 2014, according to the Government Accountability Office, the federal government’s $1.4 trillion in tax expenditures was about the same as the overall amount of federal discretionary spending. Mandatory spending is significantly larger than either category — more than $2 trillion in 2014 — and has been for the past quarter-century. (See figure 2 on the previously cited G.A.O. page.)

The G.A.O notes:

[T]ax expenditures do not compete with other priorities in the annual appropriations process, and many are not subject to congressional reauthorization. Instead, many tax expenditures operate like mandatory spending, such as Medicare, with eligibility rules and formulas that provide benefits to those who are eligible and wish to participate.

Politicians and economists often complain about corporate giveaways. Most of the benefits of tax expenditures must go to businesses, right? Actually, no. As the Tax Foundation reported two years ago:

[C]orporate tax expenditures shrunk from $159 billion in 1986 to $108 billion in 2013. Corporate tax expenditures are now less than 9 percent of the tax expenditure budget, which is lower than at any time since 1986.

• What are the biggest tax expenditures? Again, the numbers vary by year. The Bipartisan Policy Center reported in 2014 that the 10 largest tax expenditures comprised $709 billion — roughly half the total of all tax expenditures. Those items were, per Congressional data:

Exclusion of employer-sponsored health insurance, $143 billion.

Exclusion of pension contributions and earnings, $103 billion.

Preferential tax rates on capital gains and dividends, $91 billion.

Mortgage interest deduction, $72 billion.

Earned-income tax credit (EITC), $67 billion.

Child tax credit, $58 billion.

Deduction of payments for state and local taxes, $52 billion.

Exclusion of capital gains on assets transferred at death, $48 billion.

Deduction of charitable contributions (other than education and health), $35 billion.

Exclusion of untaxed Social Security benefits, $34 billion.

The Bipartisan Policy Center notes that its list “omits the exclusion for Medicare benefits, which would rank sixth at $66 billion in FY 2014. [The Congressional Budget Office’s] report does not analyze this exclusion as its distributional effects are difficult to quantify.”

• So most of tax expenditures go to wealthy people? This is largely but not entirely true. According to a 2013 Congressional Budget Office report (see table 2 on page 15), taxpayers with incomes in the top 20 percent got 51 percent of the benefits from all tax expenditures, while those in the bottom 80 percent — the bottom four quintiles, as researchers often put it — got the other 49 percent.

The difference is stark depending on what type of expenditure is examined: Ninety-three percent of the benefits from preferential tax rates on capital gains and dividends accrued to people in the top quintile. Of those, 68 percent — more than three quarters — went to people in the top 1 percent of incomes.

However, individuals with lower income get a much larger proportion of the benefits of tax credits. Fifty-one percent of earned-income tax credits go to those with the lowest income. The same bracket gets 22 percent of the benefits of the child credit, while 29 percent goes to those in the second quartile. (Combined, that’s 51 percent of child tax credit benefits going to those with the lowest 40 percent of income.) Sixty-one percent of benefits from all credits got to those in the bottom two quartiles, with only 3 percent accruing to the top 20 percent of earners.

The earned-income tax credit and child credit are among the top 10 tax expenditures. But most of the other top expenditures disproportionately benefit the wealthy.

Anywhere from 73 percent to 84 percent of the benefits from deductions for state and local taxes, mortgage interest payments and charitable contributions go to those in the top quintile. The largest exclusion, for employer-sponsored health insurance, directs 34 percent of its benefits to those in the top quintile and 60 percent to those in the top 40 percent. More than 60 percent of the benefits of two exclusions — for pension contributions and earnings and for capital gains on assets transferred at death — are garnered by the top 20 percent of earners. All told, 45 percent of the benefits of exclusions flow to the top 20 percent of earners and 68 percent go to the top 40 percent.

• So what should be done about this? In general, I agree with the principle that the tax code should be simplified, which includes reducing or cutting out many of the expenditures that disproportionately benefit the wealthy. And, in fact, this policy is promoted by politicians of other ideologies as well: Hillary Clinton’s website states that the former senator and secretary of state “will call for reform that closes corporate tax loopholes and drives investment here, in the U.S.” The same page also states that Clinton “supports ending the ‘carried interest’ loophole, enacting the ‘Buffett Rule’ that ensures no millionaire pays a lower effective tax rate than their secretary, and closing tax loopholes and expenditures that benefit the wealthiest taxpayers…” (On the other hand, Clinton calls for expanding tax breaks for both families with college students and for businesses that share profits with employees.)

Vermont Sen. Bernie Sanders’s website isn’t quite as explicit, but it suggests that he would also eliminate or reduce tax expenditures that benefit the wealthy.

But again: Tax reform isn’t an easy task; after all, if it were, wouldn’t it have been done by now? So even though this might be the sensible policy to implement, I’m cautious about assuming that this is a cure-all for federal budget issues.

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