Distributional Effects of Tax Expenditures

Distributional Effects of Tax ExpendituresBenjamin H. Harris, Katherine Lim, Eric Toder

The text below is an excerpt from the complete document. Read the full report in PDF format.

The largest tax preferences for housing, health care, and retirement saving reduce federal revenues by about 3 percent of GDP. They raise after-tax income proportionally more for higher income groups than lower income groups, but raise income proportionately less for those at the very top. The net distributional effects depend on how these tax preferences are financed. If paid for with higher marginal tax rates, they benefit upper-middle income taxpayers at the expense of both lower-income and the highest-income taxpayers, but if paid for by lower per-capita spending, all high-income groups gain and all low-income groups lose.

The Congressional Budget Act of 1974 defines tax expenditures as "revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability." The Office of Management and Budget (OMB) and the Joint Committee on Taxation (JCT) annually report estimates of tax expenditures. The term "tax expenditure" was popularized by Stanley Surrey, Assistant Treasury Secretary for Tax Policy in the 1960s, who wanted to draw attention to the increasing use of tax provisions as disguised expenditures and develop an agenda for tax reform.

By any measure, the revenue losses from tax expenditures are large. Adding up all the tax expenditure estimates in the 2010 Federal Budget, we calculate a sum of about $1.1 trillion in fiscal year 2012, or about 6.7 percent of projected gross domestic product (GDP). Of these, about $900 billion (5.8 percent) of GDP go to support social program activities (housing; education, training, and social services; health; income security, including retirement security; veterans benefits; assistance to economically depressed regions; and aid to charities and states and localities). OMB and JCT estimate each tax expenditure provision as if all the others were in place, so simply adding them together does not take account of how eliminating some tax expenditures would affect the costs of others. Totaling all the provisions may understate their cost, however. Burman, Toder, and Geissler (2008), using the Tax Policy Center Simulation Model (Rohaly, Carasso, and Saleem, 2005), find that interactions raised the total cost of a large subset of tax expenditures in the individual income tax estimated simultaneously by between 5.1 and 8.4 percent in 2007, compared with the sum of the costs of the separate estimates.

(End of excerpt. The entire report is available in PDF format.)

View the original article here

Don't Ignore Tax Expenditures

Leonard E. Burman

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Len Burman is an Urban Institute senior fellow and co-director of the Urban-Brookings Tax Policy Center.

INTRO: The President was in North Carolina and Pennsylvania today. He's been stumping like a candidate to win support for his changes to Social Security and cuts in the budget. In Detroit, Mr. Bush said it's time to eliminate the programs that don't deliver on their promises. Commentator and tax expert Len Burman likes this 'good government test'. So he wonders why hundreds of programs are getting a pass.

SCRIPT: The government should scrutinize every tax dollar it spends, but the President left more than half a trillion dollars of annual spending off the table.

I'm talking about the 160 tax expenditures administered by the IRS. Think of them as stealth spending programs hidden in the tax code.

Here's an example. Suppose you want to help poor people buy health insurance. You could have the Department of Health and Human Services give eligible families vouchers worth, say, $3,000 towards the cost of coverage for a family of four. Basically, food stamps for health insurance.

But that would be too obvious a spending program. Instead, the Bush Administration proposes to run the program through the tax code. Insurers will get $3,000 off their tax bill in exchange for a reduction in premiums.

In principle, the two programs affect government finances and the health insurance market exactly the same way.

In practice, there are worlds of difference.

The Bush plan is a "tax break," not a big new spending program. That wins it support from conservatives who are otherwise skeptical of big government.

It would effectively become another new entitlement, like Social Security and Medicare, unlike a voucher program that Congress would review annually.

And, the IRS wasn't designed to run health programs anyway, especially a behemoth like this one. As a result, insurers and their clients will have to be trusted to monitor themselves.

This is pretty much the same approach the IRS takes to most tax expenditures. That's one reason why the government comes up roughly $300 billion short of what it's owed every year.

Hidden in the tax code likes bats in caves, hundreds of programs like this get a blanket exemption from scrutiny. Until they're exposed to the same daylight as direct spending programs, we'll never get our budget under control. And we'll never have a tax system that makes sense.

In Washington, this is Len Burman for Marketplace.

View the original article here