Tax expenditures describe revenue losses attributable to provisions of 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 tax liability. These exceptions are often viewed as alternatives to other policy instruments, such as spending or regulatory programs.
Frequently Asked Questions Regarding Tax Expenditures
What are tax expenditures?
Tax expenditures are defined by 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 tax liability.” These exceptions may be viewed as alternatives to other policy instruments, such as spending or regulatory programs.
What are the largest tax expenditures? (Ten year, FY2023-2032 estimates)
- Exclusion of employer contributions for medical insurance premiums and medical care ($3,366,320 million)
- Exclusion of net imputed rental income ($1,679,550 million)
- Defined contribution employer plans ($1,535,700 million)
- Capital gains (except agriculture, timber, iron ore, and coal) ($1,492,400 million)
Are behavioral responses considered in the tax expenditure estimates?
Generally no, the estimates assume that taxpayers do not alter their choices about what activities to undertake. However the estimates do allow “tax form behavior” as taxpayers attempt to minimize tax liability. For example, the tax expenditure for mortgage interest deduction allows taxpayers to switch from itemizing deductions to taking the standard deduction if they are better off. In contrast, the tax expenditure for 401(k) contributions would not allow switching to IRA contributions, even though it is virtually the same economic activity, because the switch requires workers to purchase an IRA and in some cases requires renegotiated labor contracts to convert the firm’s share of 401(k) contributions to wages, and so involves more than simple tax form behavior.
Would repealing a provision bring in the equivalent revenue to the estimates in these tables?
No. First, tax expenditures do not include the effects of changes in economic behavior. Second, tax expenditure estimates are for fully phased in tax changes. For provisions with important timing effects, the amount of revenue brought in from repeal over a typical ten-year budget window can differ from the tax expenditure estimate. Third, tax expenditure estimates account only for changes in income taxes. Changing some tax provisions may affect other taxes, such as payroll taxes or estate taxes.
What is the difference between current revenue effects and present value effects?
The current revenue effects reports the annual cash-flow value of tax expenditures, incorporating effects of tax withholding, estimated payments, and timing of filing tax returns. The present value is a summary measure of the revenue effects over a number of years, discounted to the present to reflect the time value of money. It is especially helpful for tax expenditures that involve deferrals of tax payments into the future.
Why do some of the tax expenditures raise revenue?
A tax expenditure estimate for a provision that properly is thought of as a tax subsidy or tax break nonetheless can take on a negative value in some years, indicating that it raises revenue in those years. This happens because of timing effects. Provisions that accelerate deductions or defer the recognition of income have offsetting revenue impacts over time and, depending on the pattern of the underlying economic activity, can have a negative revenue impact in a particular year. For these types of tax expenditures the present value estimates provide a more meaningful measure of the cost of the provision.
What is a negative tax expenditure?
The Budget Act defines a tax expenditure as a revenue losing provision of tax law. A revenue increasing tax provision is sometimes referred to as a negative tax expenditure (note that this is different than a tax expenditure that is negative, see above). Examples that might be considered negative tax expenditures include the denial of a deduction of non-performance based compensation in excess of $1 million for public companies and the phase-out of the personal exemption of high income taxpayers.
Why isn’t a total for all the tax expenditures reported?
An important assumption underlying each tax expenditure estimate reported below is that other parts of the Tax Code remain unchanged. Because of interactions between provisions, generally it is not correct to add separate tax expenditures for each provision to obtain a total for repealing all at once. These interactions can increase or and decrease the estimated revenue effects of tax expenditures. For example, the individual itemized deductions for charitable contributions, mortgage interest expense, and state and local taxes are all tax expenditures. When considered individually, the sum of their effects on revenue is greater than when they are considered jointly. This is because, when all are repealed at once, it is more likely that a taxpayer’s optimal tax form behavior would be to claim the standard deduction which limits the total revenue gain from repealing the itemized deductions. In another example, due to the progressive rate schedule, considering income exclusions jointly will push some taxpayers into higher tax brackets and thus increase the joint estimate relative to the individual tax expenditure estimates.
How are expiring provisions treated?
The estimates are made relative to current law as of July 1 of the calendar year the latest estimates are released. Estimates are reported for provisions that have expired or are expiring as long as they have revenue effects in the first fiscal year listed in tax expenditure tables and beyond, until these provisions phase out and assuming no extension.