Tax Expenditures: An often overlooked yet vital component of fiscal policy, tax expenditures significantly affect economic and social outcomes. This article delves into their definitions, implications, and the political and economic dynamics that surround them.

Definition and Background

Tax expenditures indicate government revenue losses due to tax exclusions, exemptions, deductions, credits, deferrals, and preferential rates. Acting as indirect subsidies, they offer certain activities and groups preferential treatment, thus impacting the tax system's equity. For example, two individuals with similar incomes might face different effective tax rates if one receives tax benefits from expenditures like homeownership or employer-provided healthcare.

Stanley S. Surrey introduced the concept of tax expenditures in 1967. A tax scholar and former Assistant Secretary of the Treasury, Surrey used the term to call attention to political uses of tax breaks for implementing social policies, a process traditionally managed through direct government spending.

Legal Definition

As per the Congressional Budget and Impoundment Control Act of 1974 (CBA), tax expenditures are defined as "revenue losses attributable to Federal tax laws provisions which allow a special credit, preferential rate of tax, or a deferral of tax liability." This highlights the substantial budgetary implications of tax expenditures, paralleling direct government spending.

Size and Scope of Tax Expenditures

The U.S. Treasury lists over 160 tax expenditures as of the fiscal year 2020, with private social benefits such as employee healthcare being major beneficiaries. In fiscal year 2019, the Congressional Budget Office estimated U.S. tax expenditures to be $1.6 trillion or 7.8% of GDP, exceeding all discretionary spending and nearly half of total federal revenue.

Major Tax Expenditures

Key tax expenditures include income exclusions (employment-based health insurance), deductions (state and local taxes), preferential rates (capital gains), and credits (Earned Income Tax Credit). The CBO estimated that from 2016 to 2026, the top 10 tax expenditures would average 6.2% of GDP annually.

Distribution of Benefits

Primarily benefiting high-income individuals, tax expenditures like the Earned Income Tax Credit aim at lower-income households but still skew towards wealthier individuals. The CBPP reported that in 2013, the top 1% of U.S. households earned 17% of tax expenditure benefits, while the top 20% received 51%.

Political Dynamics

Tax expenditures often bypass direct appropriations due to their "off-budget" nature, requiring approval from just two committees—House Ways and Means and Senate Finance. Once enacted, they do not necessitate annual reviews, marking them as entitlements for qualifying taxpayers.

Both Democratic and Republican parties contribute to expanding tax expenditures, albeit with different focuses. Studies reveal Republicans are likelier to grow such expenditures when governing, often benefiting businesses and the wealthy. Jacob Hacker noted that this makes direct social support efforts challenging.

Socio-Economic Effects

Tax expenditures influence socio-economic factors, with measures like the Earned Income Tax Credit boosting economic mobility. Regions heavily taxing the poor, such as the Deep South, show lower mobility levels than areas granting generous tax benefits for low-income families.

Global Perspective

While this analysis centers on the U.S., other countries also implement tax expenditures to provide indirect subsidies, affecting revenue and social equity. Each nation's types of prioritized tax expenditures reflect unique economic and social objectives.

Conclusion

Tax expenditures are crucial to fiscal policy, acting as indirect subsidies impacting economic efficiency and social equity. While they signify significant revenue losses, they're politically simpler to enact than direct spending programs. Understanding their size, scope, and distribution is vital for informed policymaking and public discourse.

The political landscape surrounding tax expenditures reveals fiscal policy's complexity, with both major parties expanding them but with different emphases. The socio-economic consequences stress the necessity for balanced approaches enabling economic growth and social equity.

Continuous analysis and debate are essential to align tax expenditures with broader economic and social goals effectively. Tax expenditure reform efforts should address their revenue, equity, and economic incentive impacts, striving towards a fair and efficient tax system.