Skip to content

Are “Tax Expenditures” Really Spending in the Tax Code?

3 min readBy: Scott Hodge

During his speech yesterday, President Obama made a big point of how he would take on “taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. expenditures,” what he calls “spending in the tax code.”

What are tax expenditures and what does the President mean by “spending in the tax code”? This was one of the topics I addressed during my recent testimony before the Senate Budget Committee.

Here is an excerpt from that testimony [for the complete testimony, click here]:

According to the Joint Committee on Taxation, “tax expenditures include any reductions in income tax liabilities that result from special tax provisions or regulations that provide tax benefits to particular taxpayers.”[i] These special preferences are called tax expenditures because some people consider them the equivalent of direct spending through the tax code.

However, aside from the refundable cash outlay portion of some credits, tax expenditures are really not the same as direct spending. Instead, they are an attempt to achieve certain public policy goals by inducing or incenting taxpayers with the prospect of a lower tax bill. Essentially, lawmakers are trying to get taxpayers to achieve these policy objectives by using their own money, not “the government’s.”

To be sure, many people improperly view the forgone revenue from tax expenditures as “the government’s money.” By this view, what the tax code allows taxpayers to keep through tax preferences has thus been “spent” in the same manner as a government program.

But there is a very real moral and functional difference between the government taking $1,000 from a taxpayer and giving it to the Department of Energy for switch grass research, and a tax preference which allows that taxpayer to keep $1,000 of his own money because he purchased new windows for his home. The tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. may be poor tax policy, but the transaction is clearly one that the taxpayer chose of his own accord. The government did not actively take his money and give it to Home Depot for the new windows.

The President and many in his party are very cleverly trying to shift the terms of the debate. It is obvious that they believe that Americans will not accept higher taxes, unless of course they are on the “rich.” And they know people will not easily give up such things as the mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act (TCJA) reduced the amount of principal and limited the types of loans that qualify for the deduction. and the state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. . However, if the universe of tax deductions can be recast as “spending in the tax code,” then cutting them will sound fiscally responsible.

To be sure, I believe most all of the credits and deductions in the code should be eliminated. Clearly, eliminating “loopholes” and other distortionary tax provisions can wring some of the deadweight losses out of the economy. But raising tax revenues should not be the primary goal of tax reform.

The primary goal should be to promote long-term economic growth and better living standards for the American people. As Rep. Paul Ryan proposed in his budget plan, cutting both personal and corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rates while eliminating tax expenditures would result in both improved GDP growth and a more efficient tax system. If the byproduct of increased economic growth is more tax revenues, then that is a win-win.

[i] “Background Information on Tax Expenditure Analysis and Historical Survey of Tax ExpenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit (EITC), child tax credit (CTC), deduction for employer health-care contributions, and tax-advantaged savings plans. Estimates,” Joint Committee on Taxation, February 28, 2011, p. 2.