In Tuesday’s State of the Union address, President Obama called for ambitious reforms of the tax code: lower rates, fewer loopholes and an overall simplification. The president is right: Our tax system is needlessly complicated and inefficient. But before we can fix it, we need to understand how it works. And unfortunately, there’s a good reason why Congress has enacted more and more policy through little-noticed tax provisions: there’s less transparency surrounding taxes than any other way that government uses our money.
Currently, tax expenditures (also called tax breaks) are divorced from the budget process, despite the fact that they account for 25% of our spending. Worse, compared to other forms of spending we know relatively little about them. To be able to navigate the proposals for tax reform that are showing up in Congress and the executive branch, we need much better transparency surrounding tax expenditures. But let’s start from the beginning.
What are Tax Expenditures?
Tax expenditures are government revenue losses resulting from provisions in the tax code that allow a taxpayer or business to reduce his or her tax burden by taking certain deductions, exemptions or credits (often collectively referred to as “tax breaks”). This definition itself can be controversial: Not everyone considers all income to be taxable by default, and many believe that decreases in taxable income should not be considered foregone revenue. But those objections are a minority view among both liberal and conservative experts in tax policy. It’s commonly accepted in the world of tax policy wonks that by reducing revenues that would otherwise have been collected by the government, tax expenditures have a similar effect on the federal deficit as government spending.
Think of it more as everyone paying their income tax based on a given rate. Then, the government writes checks to people or corporations engaging in behaviors it wants to encourage, like paying interest on a mortgage, having children, or researching clean energy. Because tax expenditures tend to lower the tax burden for specific groups of people, the overall tax rate has to be increased to sustain revenues. This isn’t to say that every tax expenditure is bad, but citizens should be informed about tax expenditures the same way they demand to be informed about grant and contract spending. All taxpayers should know how much tax revenue we would get if we did not have certain tax expenditures, what the goals of these tax expenditures are, and whether they’re being achieved. Tax expenditures are embedded in legislation just like other appropriations, yet we know comparatively little about them. Just like we have program assessments for grants and contracts, we should have assessments of tax expenditures.
How Much Money Are We Talking About?
Working on the Subsidyscope project, I get the opportunity to attend our annual advisory board meetings and listen to some fascinating conversations on federal subsidies by experts in the field. Last week, I saw a great presentation by Dr. Len Burman on integrating tax expenditures into the budget process. Dr. Burman is considered an expert in the field and is working on a forthcoming paper on the topic. His talk included this slide, which I found incredibly helpful for putting the importance of tax expenditures in perspective by showing how much of the budget is devoted to each type of spending (not including the spending on the interest of the national debt):
Shares of Non-Interest Spending, FY 1982-2015
Source: GAO, FY 11 Budget and calculations by Leonard Burman
In the graph you can see the percentage of the budget afforded to tax expenditures, mandatory spending (Medicare, Social Security, etc.), discretionary defense spending, and all other discretionary spending. After watching Dr. Burman’s presentation, this graph stuck with me. Notice that the biggest two components are mandatory spending and tax expenditures. And to paraphrase Dr. Burman, these two types of spending are basically on auto-pilot. Once tax expenditures are created, they stick around, relatively invisible to Congress unless expiration dates are built in to the statute. The next biggest portion is defense discretionary spending. Since it’s politically unpopular to cut defense spending, most of the national budget discussion centers around the smallest portion of the budget: non-defense discretionary spending.
Tax Expenditures Compared to Other Spending, FY 2011
|Income Tax Expenditures||Mandatory Spending||Defense Discretionary Spending||Non-defense Discretionary Spending|
|% of GDP||7.6||14.0||4.8||4.3|
source: Len Burman, Integrating Tax Expenditures into the Budget Process
What Measurements Do We Have In Place Now?
Subsidyscope recently released a tax expenditure database for the three sectors of the economy that the project has studied so far (the full database will be published in the Spring). The database contains estimates for tax expenditures from the Treasury Department and the Joint Committee on Taxation (JCT), a congressional body, for fiscal years 2001-2013 (2015 for Treasury). However, even for years past, these are still just estimates, based on two separate models. Neither Treasury nor JCT reports on what the actual revenue losses were. For all other spending, we have outlays and balance sheets we can look to — but not for tax expenditures. Right now, we have no way of knowing how accurate these estimates turn out to be. Even putting that aside, there are some big discrepancies between Treasury and JCT data! We don’t know what kind of models they’re based on, what assumptions they make, or whether those models have been validated by history.
Tax expenditures are becoming a hot topic at the federal and state level. There are many tax reform proposals emerging from think tanks, nonprofits, interest groups and Congress. But before we can debate these plans for the future, we need to know where we are today. And that’s going to be impossible until we get serious about tax expenditure transparency.
Graphs and charts taken from ‘Integrating Tax Expenditures into the Budget Process’ by Leonard Burman. Leonard Burman is the Daniel Patrick Moynihan Professor of Public Affairs at Syracuse University. He is also a Senior Fellow at the Urban Institute. You can find the slides at scribd.