Tax Expenditures: Trends and Critiques

Publication Date: September 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

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Abstract:

Special deductions, exclusions, and exemptions (sometimes characterized as "loopholes") have always been in the tax code. In the mid-1960s, the Department of the Treasury became interested in tracking and accounting for these tax subsidies. Indeed, the term "tax expenditures" was first used at this time. Both the Department of the Treasury and the Joint Committee on Taxation prepare annual lists and estimates of tax expenditures, and Treasury's list is included in the President's annual budget submission. For FY2006, the Joint Committee on Taxation (JCT) estimates that tax expenditures will amount to $945 billion -- over three times the projected FY2006 federal budget deficit. Despite their widespread use, several concerns about tax expenditures have been voiced over the past 30 years.

One key "flaw" in the budget process identified by critics of tax expenditures is the divided treatment of tax expenditures and direct expenditure programs. In the executive branch, the Treasury draws up the tax expenditure budget for review by the Office of Management and Budget (OMB), and other administrative agencies prepare the direct expenditure budgets. In Congress, the Budget and Appropriations Committees fix the discretionary spending levels for each functional budget category, while the tax-writing committees (the Ways and Means Committee in the House, and the Senate Finance Committee) are given a revenue floor. Within this revenue level, the tax-writing committees can trade off tax rate changes with tax expenditures, and the appropriations committees can trade-off one direct expenditure program for another. Typically replacing a tax expenditure with a direct expenditure would involve moving a bill through multiple committees. Consequently, tax expenditures often either overlap or conflict with direct expenditures because they have not been integrated into the budget process for appropriations.

Tax expenditures are often alternatives to other policy instruments such as grants. Consequently, national social and economic goals are sometimes met through the tax code rather than through direct expenditures. Regardless, many experts argue tax expenditures are often less efficient than direct expenditure programs in promoting these important economic and social goals. At the same time, still other tax expenditures appear not to meet any social or economic goal. In general, tax expenditures tend to reduce the progressivity of the income tax system, and add to the complexity of the tax system from the taxpayer's point of view. Furthermore, unlike direct expenditures, the benefits of much of the tax expenditures go to taxpayers in the upper part of the income distribution, and they often subsidize an activity for which the taxpayer receives a benefit.

This report will be updated as legislative developments warrant.