The Center for American Progress has long called for greater scrutiny of “tax expenditures.” These are special exemptions, credits, and deductions littering the tax code that add up to $1.1 trillion annually. Subjecting these dozens of tax breaks to greater scrutiny is part of our broader focus on making government work better and achieving better results for the American people, which is the goal of CAP’s “Doing What Works” project.
To that end, our new “Tax Expenditure of the Week” series aims to explain the often-confusing constellation of tax breaks in a way the average taxpayer can understand. Every Wednesday we will focus on one tax expenditure, explaining what it is, what purpose it is intended to serve, and whether it is effective toward that purpose. We will also review any applicable reform proposals.
Greater examination of tax expenditures is long overdue. Tax expenditures are really just federal spending programs administered by the Internal Revenue Service, as we have emphasized. While most government agencies promote policy goals by directly spending taxpayer money, IRS programs promote many of the same goals by distributing tax breaks. Tax expenditures are accounted for differently in the federal budget, but there is no meaningful difference between the expenditures and government programs that directly spend money. Yet tax expenditures don’t get regular performance reviews to determine whether they are serving their intended purpose. And most tax expenditures are permanent fixtures of the tax code, so they tend to keep growing unless Congress specifically repeals them.
At a time of severe budget challenges, Democrats, Republicans, and independents can all agree on the core reasons to more aggressively scrutinize tax breaks:
Tax expenditures are expensive. Tax expenditures today cost the federal government about $1.1 trillion a year in foregone revenue, draining the Treasury of needed revenue. That’s about the same amount as the government will actually collect this year in income taxes. Bottom line: The holes in the tax code are as big as the tax code itself.
Tax expenditures play favorites with the tax code. Tax expenditures tend to favor certain taxpayers over others. And many of the largest tax breaks benefit the wealthy. Whether the purpose is to promote homeownership, retirement savings, or investment, tax spending programs tend to provide the largest incentives to those who need them the least, while providing little or no benefit to those who could use them the most. This “upside-down” distribution of tax spending programs calls into question their fairness and efficacy.
Tax expenditures are often inefficient and distort the free market. Tax expenditures create inefficiencies in the economy by distorting the choices people and businesses make. The government often has good reasons to provide incentives for people to do things like give to charity or buy environmentally friendly products. Sometimes it makes sense to embed those incentives in the tax code. But in a market-oriented economy, should the IRS be picking winners among competing businesses or industries?
For these reasons and others, proposals to reform our $1.1 trillion tax expenditure system are a centerpiece of the President’s Fiscal Commission’s recommendations and other bipartisan efforts to reduce the deficit.
Even conservatives such as House Speaker John Boehner (R-OH), who tend to reflexively favor tax cuts, have called for more scrutiny: “We need to take a long and hard look at the undergrowth of deductions, credits, and special carve-outs that our tax code has become,” Boehner said in an August speech. “What Washington sometimes calls ‘tax cuts’ are really just poorly disguised spending programs that expand the role of government in the lives of individuals and employers.”
But the need to better scrutinize tax expenditures is not just about deficit reduction. It is also about reviewing all government programs so that policymakers can determine which ones work, which ones do not work, and how to fix or scrap the ones in need of repair.
Our series will begin by counting down and explaining the 10 largest tax expenditures as measured by their cost to the federal treasury this year. The first installment looks at the largest tax expenditure: the tax exclusion for employer-provided health benefits.
We hope you’ll find this series useful, and we encourage your feedback. Please write to Seth Hanlon directly with any questions, comments, or suggestions.