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Budget Estimates the Costs of Tax Preferences

By: Gerald Prante

Buried inside the President’s budget released Monday was a section estimating the projected 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, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans. s through 2011. What are 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? From the budget:

The Congressional Budget Act of 1974 (Public Law 93-344) requires that a list of “tax expenditures” be included in the budget. Tax expenditures are defined in the law as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability.” (Official Budget Website)

Below is a list of the top tax expenditures on the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. side over the next five years (2007-2011). Notice the preferential treatment that medical services and housing receive in the tax code, each totaling around $1 trillion over the next five years.

Exclusion of employer contributions for medical insurance premiums and medical care: $889 billion

Deductibility of mortgage interest on owner-occupied housing (home 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 reduced the amount of principal and limited the types of loans that qualify for the deduction. ): $471 billion

Capital Gains Exclusion on home sales: $318 billion

Deductibility of charitable contributions (total): $243 billion

Exclusion of net imputed rent: $205 billion

Child Credit: $200 billion

Exclusion of interest on public purpose state and local bonds: $168 billion

Deductibility of state and local income taxes, not including property (non-business): $162 billion

Exclusion of Social Security benefits (total): $149 billion

Deductibility of property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es on owner-occupied homes: $74 billion

Another interesting aspect of these 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/local taxes paid, mortgage interest, and charitable contributions. s is to look at how the expiring of the Bush tax cuts will dramatically alter many of them when moving from 2010 to 2011. The Bush tax cuts targeted regular tax liability and did little to AMT, meaning many more taxpayers are having their liability determined by AMT. And recall that AMT takes away many deductions – most specifically the deduction for state and local taxes. Therefore when 2011 hits and people’s regular tax liabilities will supersede their AMT liability, fewer people in AMT will mean that the deduction for state and local taxes will be claimed by many more taxpayers, as one can see in the numbers:

Tax expenditure for state and local taxes paid including property taxes in 2010 = $41.7 billion

Tax expenditure for state and local taxes paid including property taxes in 2011 = $72.4 billion

On the other hand, the Bush tax cuts expiring would also mean that the child 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. would be scaled down. Therefore, the projected tax expenditure of the child tax credit would fall from $41.8 billion in 2010 to $31.7 billion the following year.

For more on the need to rid the tax code of these costly preferences and replace it with a neutral tax system that is simple and promotes economic efficiency, read Tax Foundation Chief Economist Patrick Fleenor’s piece entitled America’s Shrinking Income Tax Base Requires Higher Rates for Everyone.