As we reflect on the failure of the supercommittee to reach a deficit reduction plan, it seems the most contentious points were entitlements and taxes. While Sunlight doesn't have a position on the best way to balance taxation and spending, it is worth pointing out that these two sides of the budgetary coin have very different transparency implications.

Theoretically, I can look up exactly what we've spent on entitlements like medicare in USASpending.gov or the Department of Health and Human Services spending database, TAGGS. The demand for transparency around government spending was clearly recognized by both parties in 2006, when bipartisan legislation was enacted to create USASpending.gov, which has data on grants, contracts and loans. However, tax expenditures (aka tax breaks, deductions, credits) are subject to much less oversight, both in their transparency reporting requirements and in their visibility and accessibility to the public. This is why they've often been called "the hidden budget" or "the hidden welfare state". Right now, the government only estimates tax expenditures, instead of explicitly calculating their value.

If you're wondering why tax breaks should be considered spending, I present you with this passage from a recent Burman/Phaup article:

The late economist David Bradford (2003) famously illustrated this point by proposing, with tongue firmly in cheek, a Weapons Supply Tax Credit, which would allow arms manufacturers to sell their ordinance to the Pentagon in exchange for tax credits rather than cash. Instantly, the Defence Department’s budget would decline by the amount of transformed spending. By some measure it would look like a tax cut. Tax revenues would fall by a similar amount (or more, if weapons suppliers demanded a premium on account of the complexities and uncertainties associated with the tax credit mechanism). But government would be doing exactly the same thing. Only the accounting would change.

Most people can intuit what a government grant or contract might be like, but taxes are steeped in an accounting terminology that befuddles most people. Exclusions, deductions, credits ... how do these differ from each other and how much do we spend on them? I took a stab at classifying tax expenditures into different categories using the tax expenditure data on Subsidyscope. Here are the biggies (from 2011):

Tax Expenditures By Type (FY 2011)

Exclusions - ($392B - $399B)

An exclusion is when the government makes a policy decision that certain kinds of income just shouldn't be taxed. Period. And tax payers get to take that income right off the top of what they report as their adjusted gross income, just like they never got it. Examples of this include combat pay to members of the armed forces, medicare payments, and social security payments. Often, this can put you into a lower tax bracket, thus reducing the tax rate you pay, as well as the amount of income you have to pay it on.

To put this $390B number in perspective, consider that in FY 2011 we spent $335 billion on all government contracting. Would it be acceptable in this day and age to say we don't need transparency and accountability around contract spending?

Deductions - ($263B - $257B)

Deductions are similar to exclusions in that you can use them to reduce what part of your income you're allowed to be taxed on. However, instead of being defined by the type of income received, they're often defined as what major expenses you've had to pay this year. For instance, you can subtract whatever you paid in interest on your mortgage from your taxable income, as well as whatever you paid in state and local taxes.

Credits - ($109B - $132B)

Credits are a dollar for dollar reduction in your actual tax bill. So after you go through the entire exercise of calculating what your tax owed is, based on your income, you get to subtract the value of the credit from that amount. Examples of this include the child tax credit, or the credit a business gets for investing in clean coal.

All Others - ($300B - $309B)

Other tax expenditures, like deferments, treatment of certain income as capital gains, or mixed types, account for $300B. Deferments allow you to shift your tax burden from year to year. For corporations, this can mean choosing to deduct an equipment investment several years from now when you may be operating with a higher profit margin. For individuals, it can be used for retirement accounts, where you defer paying tax on the money in that account until you retire, and are subject to a much lower tax rate. Sometimes other types of income will be taxed at the lower capital gains rate instead of the normal income tax rate, such as royalty income on coal.

There are a lot of arguments to be had about what our tax system should be like to begin with. Should we have consumption based taxes or income taxes? And what should rates be? Len Burman and Marvin Phaup have described our current system as a hybrid of a consumption and income based tax system, which makes determining the starting point (or baseline) even more difficult. Currently, tax expenditures are estimated to cost us over $1 trillion (for 2011). Even if we change our starting point for estimation to be either a pure consumption or pure income tax system, it's estimated that $800 billion would still be considered tax expenditures under either system.

The bottom line: tax expenditures are a type of spending just like contracts or grants, both in practice and magnitude. We need more transparency about how much we actually spend on them, and transparency from law makers when they present plans that contain tax expenditures, instead of intentional obfuscation.

My classifications of tax expenditures into the different types can be found here and a summary spreadsheet here.

Federal tax expenditures are now fully digitized and easily searchable with a new tool released yesterday by SubsidyScope, a project of the Pew Charitable Trusts. Tax expenditures are (essentially) federal spending made through the tax code and amount to the rough equivalent of 1/4 of the federal budget. The website behind Pew's Tax Expenditure Database was developed by the Sunlight Foundation, and contains federal income tax expenditure estimates from 10 years of budget documents for all economic sectors.

The Advisory Committee on Transparency, a project of the Sunlight Foundation, recently hosted a panel discussion on increasing tax expenditure transparency, which featured William Beach of the Heritage Foundation, Thomas Hungerford of the Congressional Research Service, Lori Metcalf of the Pew Charitable Trusts, Eric Toder of the Urban Institute, and Jesse Feinberg from Rep. Mike Quigley’s office. Background information on tax expenditures is available here. The video is available below.

In a fiscal climate where every penny counts, the rough equivalent of one-quarter of this year's federal budget went to tax breaks known as “tax expenditures,” amounting to around 1 trillion dollars. Compared to traditional government spending through contracts and grants, tax expenditures are harder to track, subject to less congressional oversight, and caught up in ideological debates over definitions.

The Advisory Committee on Transparency's panel of experts will explore the trillion dollar question of how tax expenditures fit into the overall budget process. Confirmed panelists include:

• William Beach, Director, Center for Data Analysis, the Heritage Foundation
• Robert Carroll, Principal, Ernst & Young's Quantitative Economics and Statistics Group; former Vice President for Economic Policy at the Tax Foundation; former Deputy Assistant Secretary for Tax Analysis, Office of Tax Policy, Treasury Department
• Thomas Hungerford, Specialist in Public Finance, Congressional Research Service*
• Lori Metcalf, Project Manager, SubsidyScope, The Pew Charitable Trusts
• The Honorable Mike Quigley, Fifth District of Illinois
• Daniel Schuman, Moderator, Policy Counsel, The Sunlight Foundation
• Eric Toder, Institute Fellow, the Urban Institute; Director, Office of Research, IRS (2001-04); Deputy Assistant Secretary for Tax Analysis, Treasury Department (93-96); Deputy Assistant Director for Tax Analysis, CBO (84-91); Financial economist and deputy director, Office of Tax Analysis, U.S. Treasury Department (76-84)

The discussion will take place on Monday, June 13th, at 2pm, in Rayburn 2203.

All are welcome. RSVP here.

(cross-posted at the Advisory Committee on Transparency's website.)

*for identification purposes only

On June 13th, the Advisory Committee on Transparency will hold a panel discussion on tax expenditures, entitled "the Hidden Budget," set for 2pm in the Rayburn building. Our panel of budget experts and advocates will explain what tax expenditures are, follow the more than $1 trillion dollars in annual spending via tax expenditures, and explore proposals for making tax expenditures more transparent.

More information will be available shortly.

(Cross-posted from the Advisory Committee website.)

On Monday I wrote about tax expenditures and their lack of transparency and we published a short quiz on tax expenditures. Today, I’m focusing on tax collection and how we can make it easier for both the user and the government. In a recent report, the GAO noted that enforcement and collection of taxes owed is getting to be a more serious issue and a huge source of lost revenue, estimated at $330 billion at the end of 2010. The GAO also issued two other reports that identified paid tax preparers as part of the compliance problem and also briefed the Senate Finance Committee on tax collection practices in other countries that the US might benefit from. Here’s a table of some of the more interesting tax collection practices in other countries:

source: http://www.gao.gov/products/GAO-11-540T

Instead of looking at discretionary spending and tax spending in separate vacuums, New Zealand analyzes both types of spending by goal. This helps prevent duplicative spending and shows which method of delivery is the most effective. And Finland has the holy grail! Finland has the Tax Card system, a website where users can enter information to accurately calculate their withholding multiple times a year, adjusting for events that increase or decrease their tax liability (Finland also automatically notifies the employer of any changes so the taxpayer doesn’t have to fill out any paperwork). Then, at the end of the year, taxpayers get a prepared tax return that they can either submit as is or make changes to. Government prepared returns are proven to increase compliance in tax collection. They also allowed Finland to reduce its tax compliance staff by 11%! Taxpayer savings all around!

In the US, the state of California has a pilot program that accomplishes the same thing, called ReadyReturn. It’s safe to say that Intuit (the publisher of Turbo Tax) isn’t happy with ReadyReturn. Just check out the Influence Explorer page for Intuit and look at who they contribute to:

(It’s worth nothing that President Obama made a proposal during his campaign to have a pre-filled tax return mailed to tax payers)

Moving the IRS into the digital age not only has benefits for tax payers and increases taxpayer compliance, but it would also make it easier to collect real, historical data on how much money the federal government actually spends on individual tax expenditures and which recipients are benefiting. This data collection is crucial in making tax expenditures more transparent.

To read more, we’ve provided a handy list of resources below. Also, head over to our quiz to see how much you know about tax expenditures!

• The Subsidyscope Tax Expenditure database
• Analytical Perspectives, Budget of the United States
• Joint Committee on Taxation - Tax Expenditure Estimates
• The Center for American Progress’ Tax Expenditure of the Week
• Tax Expenditures and Government Size and Efficiency, by Len Burman and Marvin Phaup
• GAO Report - Opportunities to Reduce Potential Duplication in Government Programs, Save Tax Dollars, and Enhance Revenue
• Good Jobs First Subsidy Tracker

It’s that time of year again! With tax day upon us, many people might be wondering where all of their tax dollars are going. For most types of government spending, you can actually research this question. But there’s one type of spending that often goes overlooked by the public and legislators: tax expenditures. I’ve written about tax expenditures and why they’re important, but here’s the quick version: tax expenditures are taxes that weren’t paid to the government because of specialized exemptions for certain groups of people or corporations. Economists generally equate them with federal spending, but they are not subject to the same scrutiny or evaluation as other federal spending. We think that needs to change. In celebration of tax day, Sunlight presents part one of a quick introduction to the world of tax expenditure transparency, along with a super-fun quiz to top it all off!

Tax Expenditures Lack Transparency and Oversight

Chances are, you take advantage of some tax expenditures. If you have children, or pay interest on a mortgage, or fall below a certain income level, then you’ve probably taken advantage of the Child Tax Credit, the Mortgage Interest Deduction, or the Earned Income Tax Credit. If you have taken one of these credits or deductions, you paid an effective tax rate that was lower than the standard tax rate for everyone else with the same income as you. As a result, everybody else’s income tax rate has to be higher. Since I don’t have children or a mortgage, my tax rate is inflated to make up for the lost revenue from tax expenditures like the ones I just mentioned.

That is not to say that all tax expenditures are bad. We aren’t in a position to make judgments about specific tax expenditures. But we are in a position to say that government spending through the tax code is opaque and lacks oversight. Here are some ways in which tax expenditures are less transparent than other types of spending, like grants and contracts:

1. Actual lost revenue is not measured - Only estimates for the lost revenue from tax expenditures are calculated. These estimates are produced by the Joint Committee on Taxation (JCT) and the Department of Treasury, not the IRS. The IRS could go back and measure the actual costs associated with tax expenditures using a sampling methodology, but they don't.
2. Discrepancies between estimates - The two bodies that make estimates (JCT and Treasury) often have widely varying estimates for the same tax expenditures. With both these bodies staying pretty tight lipped about how these estimates are made, it’s hard to know which one is more accurate. For example, Treasury estimates the Earned Income Tax Credit at $4.9 billion for 2010, but JCT estimates $56 billion.
3. Inconsistent descriptions and classifications of tax expenditures - In addition to having a difference of opinion over what we actually spend on tax expenditures, JCT and Treasury also organize, classify and describe tax expenditures differently. Sometimes this makes it incredibly difficult to know if you’re comparing the right estimates across JCT and Treasury.
4. Once enacted, tax expenditures are on autopilot - Just like Otto in Airplane!, most tax expenditures will just sit there, happy and contented forever. Once tax expenditures are enacted, most of them just stay on the books, year after year, without congressional oversight, or even an evaluation of their performance.

With tax expenditures being over 25% of our total spending, they should be under just as much scrutiny as grant and contract spending. Their relative obscurity is the reason they are politically popular vehicles for spending. The only way to keep legislators from using the tax code to enact their private spending agendas is to shine a nice big light on it.

Little Things Can Go A Long Way

There are some things that could happen right away to open up tax expenditures. If the Department of Treasury and the Joint Committee on taxation created a taxonomy, or agreed on a general schema, for reporting tax expenditure estimates, comparing them would be much easier for the average citizen who is not a tax expert or economist. Even just having a common identifier for each tax expenditure would go a long way. They could also release their tax expenditure estimates in a spreadsheet format, instead of a 200 page PDF. These steps require no money, only a little time and collaboration between the branches of government.

In the longer term, Congress could give the IRS a mandate for data collection. They could also institute statutory requirements for the systematic review of enacted tax expenditures and incorporate this review into the budgeting process. The executive branch could facilitate cooperation between the IRS and other federal agencies that disburse direct funding so that they can analyze the effectiveness of both types of spending on the same goals and publish their findings. There are a whole host of measures that could be taken to increase tax expenditure transparency, and we need them now more than ever.

Head over to our quiz to see how much you know about tax expenditures and have a happy tax day!