Tax Expenditures—The $1.5 Trillion Elephant in the (Budget) Room

The Biden government’s budget proposal for fiscal year 2022 provides for additional revenue of $ 2.4 trillion over the next 10 years. Higher tax rates for high-income individuals and businesses add up to $ 990 billion. At the same time, the budget provides for $ 1.35 trillion in new tax expenditures from exemptions, exclusions and deductions. A thorough examination of the profitability of new and existing tax expenses and their possible economic effects is therefore of crucial importance.

Tax expenses are expensive

Tax expenditures are special provisions of the tax code that reduce tax debts for certain activities or groups of taxpayers in order to pursue different political goals. The federal government uses tax expenditures such as special deductions, allowances and reduced rates to implement various support and incentive programs with the aim of supporting certain sectors or social groups.

According to the Treasury Department, the federal government foregoes around $ 1.5 trillion each year by implementing income-related tax spending. That corresponds to 6.8% of GDP and more than a third of federal spending. The top 5 provisions for income-related tax expenses account for more than 40% of the total (Figure 1).

Illustration 1. Five Largest Provisions for Tax Expenses in the United States, FY2020

Source: Treasury Department Tax Spending Report for Fiscal Year 2022.

Note: Includes general capital gains tax expense (Regulation No. 66 in the report), but also capital gains treatment of coal taxes, certain timber income and certain agricultural income; Capital Gain Exclusions on Home Sales and Small Business Stocks; Top-up base of investment income in the event of death; Transfer basis of capital gains from gifts; and deferment of profits from similar exchanges.

Unlike the other G-7 economies, the tax expense reports of both the Treasury and the Joint Tax Committee only include estimates of revenue shortfalls related to income taxes. The cost of tax expenses related to other federal taxes – such as wage taxes, consumption taxes, and inheritance and gift taxes – are not included in these annual reports. Therefore, the total numbers given above are to be seen as the lower bound.

According to the newly published Global Tax Expenditures Database, the fiscal cost of tax spending in the US is well above the OECD average (4.4% of GDP) and globally (3.7% of GDP) (Figure 2). Since the US figures only include those that relate to income taxes, the difference is likely to be even greater.

Figure 2. Tax Spending to GDP Ratio, G-7 Economies

Source: Global Tax Expenditure Database

Note: Based on data for 2019. Japan and Germany are based on data for 2018, the last available year. The OECD and world averages are calculated on the basis of the latest available data for each country, which may vary from case to case.

Tax spending can be ineffective and have negative side effects

Aside from their fiscal costs, many tax expense provisions fail to meet their stated goals and can have negative side effects such as worsening inequality. For example, as is so often the case with individual income tax expenses, provisions for home-related tax expenses are highly regressive. In the United States, several home-related costs – such as mortgage interest payments – are deductible from taxable income. However, for the US and elsewhere, there is evidence that Home Ownership (MID) regulations have little or no impact on home ownership rates. And they can have a significant impact on the public purse. Over the next 10 years, MID is estimated to have US $ 600 billion in revenue

The exclusion of capital gains from the sale of a primary residence from taxable income is estimated to result in another loss of federal revenue of $ 500 billion over that period. In addition, the distribution of these tax benefits is heavily geared towards top earners. The Tax Policy Center estimates that while a little more than 8% of all tax units benefit from the MID, more than 60% benefit from the top 1% of the income distribution.

In general, tax expenses based on capital income and wealth are particularly regressive and disproportionately benefit high-income and affluent households, e.g. In this context, tax expenditures, provided they favor higher-income and affluent households, can aggravate racial gaps.

Well, tax spending isn’t bad per se. For example, the Earned Income Tax Credit (EITC), a refundable tax credit that subsidizes low-income working families, demonstrably supports single people – especially women – and main breadwinners among married couples for employment. It also has long-term positive effects on children’s educational and employment outcomes.

Tax expenses in Biden’s tax plan

Biden’s proposal provides for the abolition of several tax expenditures, such as the abolition of fossil fuel tax preferences, the taxation of long-term capital gains and dividends at the ordinary tax rates, the taxation of capital gains as disposals on transfer or death, and the abolition of exchange statements of the same kind. These measures should increase tax revenue by $ 440 billion. On the other hand, new and expanded tax spending would reduce government revenues by $ 1.35 trillion over the next 10 years.

The largest expansion is in employee and family support totaling $ 822 billion, with the largest provision being to extend the child tax credit increase through 2025 and make the $ 449 billion credit fully recoverable. To make dollars permanent. Likewise, the new, expanded, and expanded alternative energy incentives total $ 349 billion, while the enhanced R&D incentives total $ 124 billion and housing and infrastructure support totaled $ 61 billion over 10 years.

Interestingly, nearly 90% of the expanded tax expense – $ 1.2 trillion – will come through spending rather than reduced tax collections due to recoverable tax credits. This shows that tax expenses are no different from direct payments of grants or transfers, where checks are sent to the recipients.

The Biden government is expanding the federal income tax base by eliminating many tax expenditures while increasing tax rates for high-income taxpayers and corporations. At the same time, the administration uses the tax system to provide additional tax expenditure for the restructuring of economic and social programs. The tax-to-GDP ratio is expected to increase in the coming years as new and expanded tax expenditures outweigh those canceled and, in addition, higher tax rates increase lost revenue from remaining tax provisions.

In fact, a large part of the goals in Biden’s Made in America Tax Plan is to change tax spending to pursue policy goals like “Establishing corporate tax law to incentivize job creation and investment here in the United States States offers …[and] Abolition of fossil fuel tax preferences as part of the president’s commitment to putting the country on the path to net zero emissions by 2050. ”The effectiveness of the budget proposal affecting the tax expenditure system will therefore largely determine the success of the Biden government in achieving their goals.

This column does not necessarily represent the opinion of the Bureau of National Affairs Inc. or its owners.

Information about the author

Tom Neubig is with the Council on Economic Policies and a founding member of the Tax Sage Network. Agustin Redonda is a member of the Economic Policy Council.

Bloomberg Tax Insights articles are written by seasoned practitioners, academics and policy experts who discuss developments and current issues in the tax field. To make a contribution, please contact us at TaxInsights@bloombergindustry.com.