Tax expenditures—special tax credits, deductions, exclusions, exemptions, deferrals, and preferential tax rates—substantially reduce federal income tax revenue. However, policymakers and the public do not always know how successful tax expenditures are in achieving their intended policy goals.
Based on U.S. Department of the Treasury estimates for fiscal year 2012, the federal government had forgone more than $1 trillion in tax revenue through 169 tax expenditures. The tax revenue that the government forgoes is viewed by many analysts as spending channeled through the tax system.
Figure 1: How to Evaluate Tax Expenditures, Excerpt
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- Since 1994, GAO has recommended greater scrutiny of tax expenditures, as periodic reviews could help determine how well specific tax expenditures work to achieve their goals and how their benefits and costs compare to those of other programs with similar goals. Just like spending programs, tax expenditures, if well-designed and implemented, can be an effective tool to achieve federal goals, such as encouraging economic development in disadvantaged areas, financing postsecondary education, and stimulating basic research and development. However, their success in achieving these goals may be measured and assessed less often than that of other programs with similar goals. Again, like spending programs, some tax expenditures may be ineffective at achieving their intended purposes, or they may duplicate other federal efforts.
- In recent years, spending through the tax code has approached the size of federal discretionary spending (Figure 2 compares tax expenditures to other federal spending). However, tax expenditures do not compete with other priorities in the annual appropriations process, and many are not subject to congressional reauthorization. Instead, many tax expenditures operate like mandatory spending, such as Medicare, with eligibility rules and formulas that provide benefits to those who are eligible and wish to participate.
Figure 2: Tax Expenditures Approach the Size of Discretionary Spending
Source: GAO analysis of Treasury estimates and OMB historical data.
Note: Summing tax expenditure estimates is a useful gauge of size but does not take into account possible interactions among individual tax expenditures.
- Tax expenditures have a significant effect on overall tax rates as well as the budget outlook. The revenue the federal government forgoes from tax expenditures reduces the tax base and requires higher tax rates to raise any given amount of revenue. In addition, tax expenditureslike any federal program spendingreduce the amount of funding available for other federal activities, increase the budget deficit, or reduce any budget surplus.
- Finally, tax expenditures may be part of broader tax reform discussions. (See also Tax Reform.) Figure 3 shows the six largest tax expenditures which accounted for half of all revenue forgone in fiscal year 2012. The myriad of tax expenditures add to tax code complexity. (Figure 4 shows examples of the different tax expenditure types.) Eliminating or combining tax expenditures is one way to simplify the tax code, but this would reduce incentives for activities that have been encouraged by the tax code. Also, tax reforms that move away from an income tax system to some other system, such as a national consumption tax, could affect which tax provisions are considered tax expenditures.
Figure 3: Largest Income Tax Expenditures in Fiscal Year 2012
Source: GAO analysis of Treasury estimates.
Notes: Not all provisions that reduce a taxpayers liability are considered to be tax expenditures. Some provisions are considered to be part of the normal income tax. For example, business expense deductions are not considered tax expenditures because taxpayers are allowed to deduct the costs of earning income. Both Treasury and the Joint Committee on Taxation estimate the revenue loss for each tax provision they have identified and report as a tax expenditure.
aThe value of employer-provided health insurance is excluded from Medicare and Social Security payroll taxes, and Treasury estimated that the payroll tax revenue losses were $107.8 billion in 2012.
Figure 4: Examples of Six Types of Tax Expenditures