How tax expenditures distort our understanding of the U.S. tax code

Photo of tax payment by GStudio Group,

There are certainly good reasons to subsidize the adoption of electric cars. And there are certainly a number of ways to effectively push consumers to move into the electric market. But using a tax break originally designed to encourage farmers to invest in large equipment to now encourage people to buy a Tesla Model X probably isn’t one of them. The benefit from this tax break will almost certainly go to the wealthy individuals who were already going to buy these cars in the first place. This story is just an exaggerated example of some of the many problems with the number of loopholes and deductions in the U.S. tax code.

A recent piece by Politico tax reporter Katy O’Donnell details one of the issues with tax deductions: They are a shadow budget because the spending doesn’t show up on the official U.S. budget. Deductions are often called “tax expenditures” because specific tax breaks act very much like government spending. Consider the mortgage interest tax deduction: In practice, the tax break acts like giving money to a taxpayer with a mortgage, with the amount of the payment depending on the mortgage’s size.

Despite acting like spending, tax expenditures aren’t registered on the U.S. federal budget like the rest of spending. So while the rest of the spending in the budget gets voted on every year, most tax expenditures roll on unaccounted for. If you want to see how much the federal government has spent since 1789, for example, that data is easily available and downloadable on the Office of Management and Budget website. Finding the amount of spending through the tax code for just the last two years, however, requires finding a PDF squirreled away on a separate page.

But the general public doesn’t seem to miss the number of loopholes and deductions. Around tax time, looking at the number of potential deductions you might qualify for can be daunting. Or, perhaps, it makes you wonder who exactly is taking advantage of these loopholes. In an opinion piece for Morning Consult, Vanessa Williamson of the Brookings Institution and Andrea Louise Campbell of the Massachusetts Institute of Technology note how a number of people they interviewed about the tax code believed that they were missing out on the benefits of deductions and credits while the rich were raking it in. Interestingly, this is why many of them supported a flat tax. They thought the elimination of loopholes would result in the rich paying a higher share of their income.

These people’s intuitions about the incidence of tax expenditures are correct—the benefits of spending through the tax code go disproportionately to high-income taxpayers. But the overall distributional effects of a flat tax would be overwhelmingly regressive. Tax reform that streamlines these breaks but keeps a progressive structure would end up meeting the criteria of the taxpayers that Williamson and Campbell interviewed.

So not only are tax expenditures inefficient and inequitable, but they are also opaque. They give a misleading picture of the actual amount of federal government spending, and they make taxpayers question the structure of the code itself. The case against tax expenditures only continues to get stronger.

October 26, 2015


Nick Bunker


Individual Taxation

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