Q. What are tax expenditures, and why are they in the news?
A. Tax expenditures are defined in the Congressional Budget Act of 1974 as lost federal income due to provisions in the tax code that exempt or reduce taxes for certain groups, products or activities. Tax expenditures were intentionally passed by Congress for certain policy goals, such as encouraging employer-provided health insurance or home ownership, so they are also called tax incentives. Since they help achieve goals set by Congress, they are not loopholes. The debate in Washington over reducing the federal debt has invoked whether certain tax expenditures should be ended. Stopping these tax expenditures would raise money for the federal Treasury but also would take away tax incentives that are used by tens of millions of middle-income taxpayers. There’s also controversy over whether the amount of revenue raised by ending some of the tax expenditures is overstated and whether the revenue gained would be worth ending policies that support widely desirable behavior, like pension plan contributions.
Q. What are the biggest tax expenditures?
A. An analysis by Senator Orrin Hatch of Utah, who serves as Ranking Member of the Senate Committee on Finance, which is responsible for tax legislation, determined these top 10 largest tax expenditures. The analysis was based on data from the nonpartisan Joint Committee on Taxation, Congress’ official estimator for the cost of tax legislation.
Exclusion for Employer-Provided Health Insurance.
Representing 13 percent of tax expenditures, it’s the single largest tax expenditure. To do away with this would threaten access to health care for families and individuals that have health insurance through their employers.
Home Mortgage Interest Deduction.
Having helped millions of Americans achieve home ownership, this expenditure accounts for nine percent of all tax expenditures.
Preferential Rates for Dividends & Capital Gains.
Take away this tax expenditure which accounts for eight percent of tax expenditures, and the rate on dividends will almost triple in less than 18 months, and the rate on capital gains will go up 59 percent, also in less than 18 months. This will discourage investment in stocks and bonds.
Exclusion of Medicare Benefits.
Accounting for seven percent of tax expenditures, its elimination would increase taxes seniors’ Medicare benefits.
Pre-Tax Treatment of Defined Benefit Pension Plan Contributions.
This is a tax benefit that reduces the cost for those workers who save for retirement. It represents six percent of tax expenditures.
Earned Income Tax Credit.
Designed for low-income people, the Earned Income Tax Credit accounts for five percent of all tax expenditures.
Deduction for State and Local Taxes.
This deduction would hit high-tax states hardest, driving up the marginal rate of taxpayers who take this deduction by as much as 35 percent. It represents five percent of all tax expenditures.
Pre-Tax Treatment for Contributions to a 401(k).
At four percent of tax expenditures, this is a significant incentive to families and individuals to save for retirement.
Exclusion of Capital Gains at Death.
If this one goes, death would be taxed twice. First, the decedent’s estate might get hit with the death tax. Then the decedent’s heirs would be subject to tax again on the gain embedded in any inherited asset, should they decide to sell it. This accounts for four percent of tax expenditures.
Deductions for Charitable Contributions.
This is the tax benefit for donations to charities other than education and health care institutions, including donations to religious institutions. This charitable deduction represents four percent of tax expenditures.
Source: Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2010-2014,” December 21, 2010. http://www.jct.gov/publications
Q. Are tax expenditures the same as tax loopholes?
A. Despite some political arguments to the contrary, tax expenditures are neither spending nor tax loopholes for millionaires, yachts or corporate jets. Less than one-tenth of one percent of all tax expenditures benefit corporate jet owners. Tax expenditures are used by many families and individuals. Consideration of them by Congress should be done in a comprehensive tax reform debate to make sure the tax code is made more efficient and no more burdensome than it is today.