Our federal budget is in need of reform. Though the federal deficit has decreased in recent years, we still face an exorbitant shortfall that will grow in the coming years. We expend a countless amount of energy discussing how to reduce discretionary spending, but rarely discuss tax expenditures, another huge component of federal spending. If we truly wish to get our fiscal house in order, it is time to count tax expenditures as what they really are – spending. We should include them as part of the normal budget process so they can regularly be considered for cuts and reforms.
Tax expenditures are revenues lost due to provisions in the tax code, usually aimed at encouraging a certain behavior or policy. For example, when you deduct your mortgage interest from your taxable income – the third largest individual tax expenditure – the tax that would have been paid on that money is revenue lost to the Treasury’s coffers. The government could achieve an equivalent outcome by creating a housing spending program that gives the same amount of money to consumers to subsidize mortgage interest directly, instead of through the tax code. The decision about this is partially a political calculation – a tax cut sells better than spending programs. But the tax deduction mechanism does not make this program substantially different than if it were administered as pure spending. This is not to say that all tax expenditures are bad. However, we cannot exempt them from being considered spending when we are looking at the overall budget picture.
Tax expenditures are a huge part of overall spending: about $1.5 trillion in FY 2015 according to the Congressional Budget Office. By its estimate, this is more than the projected spending for Medicare, Social Security, or defense. Tax expenditures are also expanding, with 96 percent real dollar growth since 1991. Additionally, because many tax expenditures are permanent parts of the tax code, there is no affirmative decision to keep them going each year. Instead, they go on autopilot, growing year after year.
As we seek to trim budgets, all forms of spending should be on the table.
Including tax expenditures as part of the regular budget process could increase the fairness of spending cuts. Tax expenditures are generally regressive – benefitting the wealthy the most – because deductions and exemptions have value relative to what the marginal tax rate would have been on that income. For example, there is a block grant program to subsidize the cost of childcare for families at or below 85 percent of the poverty line; because of spending caps, the program is limited in its reach, with long waitlists for enrollment. At the same time, there is a tax credit for a percent of childcare spending that is available to all filers with positive tax liability; because it is not refundable, the benefit is skewed toward higher income households. The two programs have the same goal of subsidizing childcare costs, but one faces a spending cap while the other is an unlimited tax expenditure. These programs share a common purpose, but do not face the same level of scrutiny and oversight, particularly in light of across-the-board discretionary spending cuts. As we seek to trim budgets, all forms of spending should be on the table.
Some opponents of including tax expenditures directly in the budget process point to issues with how to define and measure tax expenditures. Deciding which tax policies are deviations from a “normal income tax” and thus are expenditures, and which are not is somewhat of a subjective conversation. For example, the Joint Committee on Taxation and Treasury’s Office of Tax Analysis have disagreed in the past over this distinction. Additionally, a set of assumptions about behavior changes and other factors has to be made to calculate expenditure estimates, about which there can certainly be disagreement, especially now, in light of dynamic scoring. These are tough issues that would need to be addressed, but they are not insurmountable problems.
Given all of the calls for reducing spending as the budget process for fiscal year 2016 gets underway, let us remember what tax expenditures truly are and try to move the needle on much-needed reforms.
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