Cleaning Up the Tax Code Could Raise Trillions for Tax Reform

As Republicans look for ways to offset the budgetary cost of extending the expiring provisions of the 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. Cuts and Jobs Act (TCJA) and potentially enacting other tax cuts, the latest estimates indicate several trillion dollars could be raised by reducing tax credits and other preferences in the tax code. Many preferences amount to spending through the tax code, adding trillions of dollars to deficits without sufficient budgetary scrutiny while complicating taxes and adding compliance costs for taxpayers.

The Treasury Department identifies 170 different tax expenditures that, taken together, are expected to reduce federal tax revenue by more than $28 trillion over the next decade, including income tax, payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. , and outlay effects. The Joint Committee on Taxation produces a similar list, estimating tax expenditures will reduce income tax revenue by about $11 trillion from 2024 to 2028.

Simply eliminating all tax expenditures would not result in budgetary savings equal to the total of all 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, nor would it be a sensible approach to reform.

First, tax expenditure estimates are not quite the same as revenue estimates, as they do not account for changes in behavior or the economy, interactions with other provisions, or certain timing effects over the 10-year budget window.

Second, simply eliminating all official tax expenditures would remove important provisions that reduce the economic harm of the income tax by reducing its bias against saving and investment. For example, 401(k)s provide individuals a more neutral treatment of saving versus consumption, while expensing provisions allow businesses to more fully recover their investment costs.

Putting aside broad-based provisions aimed at saving and investment, there remains more than $18 trillion of tax expenditures from 2025 to 2034, according to Treasury’s estimates. Of these, about $3.6 trillion is from refundable tax credits, and about $2.3 trillion of that amount is the refundable portion technically counted as federal outlays. Arguably, the entire $3.6 trillion represents spending through the tax code, as it does not depend on tax liability.

Several green energy credits, extended and expanded as part of the Inflation Reduction Act (IRA) of 2022, comprise the largest category of refundable tax credits. Treasury estimates 16 different green energy credits will add about $1.2 trillion to deficits from 2025 to 2034, about $1.1 trillion of which is due to refundable credits, including the energy production credit ($304 billion), tax credits for clean vehicles ($206 billion), and the advanced manufacturing production credit ($190 billion).

Many green energy credits are accessible to taxpayers with no tax liability and to tax-exempt entities, such as nonprofits and governmental entities, through transferability and direct pay. Rolling back or capping the accessibility of green energy credits could reduce deficits. Treasury estimates the refundable portion of the green energy credits will add about $341 billion to deficits over the next decade.

Outside of the green energy credits, the single largest refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). is the Affordable Care Act’s health insurance premium assistant 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. , which Treasury estimates will cost $1 trillion over the next decade, $897 billion of which is outlays. The American Rescue Plan Act of 2021 and the IRA temporarily expanded the premium tax credit through 2025, after which its cost will drop from $105 billion in 2025 to $90 billion in 2026.

Two other large refundable credits, the earned income tax credit (EITC) and the child tax credit (CTC), are long-standing parts of the tax code, though the TCJA’s more generous CTC is set to expire at the end of this year under current law. Treasury estimates the EITC will cost $822 billion over the next decade, of which $771 billion is outlays, while the CTC will cost $499 billion, of which $291 billion is outlays. If not extended as part of TCJA, the annual cost of the CTC will drop from $106 billion this year to $87 billion next year and about $39 billion each year thereafter.

Many other tax expenditures beyond refundable credits should be scrutinized for budgetary savings. The single largest tax expenditure is the exclusion of employer medical insurance premiums and medical care, which Treasury estimates will add $5.9 trillion to deficits over the next decade, including payroll and income tax effects. This is a huge and distortionary loophole that has grown for decades and will continue to grow as employers shift more compensation toward this untaxed fringe benefit and away from taxed cash compensation.

Other large tax expenditures for individuals include the deduction for state and local taxes (SALT), estimated by Treasury to cost $1.5 trillion over the next decade, and the deduction for mortgage interest (MID), estimated to cost $904 billion. These are measured against current law, which assumes TCJA’s $10,000 cap on SALT deductions expires at the end of this year along with TCJA’s tighter limits on mortgage interest deductions.

Finally, the business tax code includes several questionable preferences beyond green energy credits (which are mainly claimed by business taxpayers), carving out special treatment for certain businesses and industries. This includes the credit for low-income housing investments (estimated to cost $167 billion over the next decade), the exemption of credit union income ($32 billion), the new markets tax credit ($8 billion), and special tax benefits for Blue Cross/Blue Shield ($6 billion).

In short, lawmakers have a multitude of pay-for options just within the official list of tax expenditures, sufficient to offset several trillion dollars of tax cuts. As a bonus, many expenditures represent spending through the tax code or otherwise non-neutral treatment of taxpayers that should be cleaned up as part of tax reform. Indeed, curtailing or repealing such expenditures could mean the difference between a simple tax-cutting exercise, which would necessarily be limited and potentially temporary due to budgetary concerns, and a more lasting and fundamental overhaul that both simplifies taxes and creates better incentives for long-run economic growth.

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