Tax Policy:

Tax Expenditures Deserve More Scrutiny

GGD/AIMD-94-122: Published: Jun 3, 1994. Publicly Released: Jun 7, 1994.

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Pursuant to a congressional request, GAO reviewed tax expenditure growth, focusing on: (1) the size of increases in tax expenditures; (2) whether tax expenditures need increased scrutiny; and (3) options that could be used to control the growth of tax expenditures and the advantages and disadvantages of each alternative.

GAO found that: (1) substantial revenues are forgone through tax expenditures, but they do not overtly compete in the annual budget process and most are not subject to reauthorization; (2) policymakers have few opportunities to make explicit comparisons or trade-offs between tax expenditures and federal spending programs; (3) the revenues forgone through tax expenditures reduce the resources available to fund other programs or reduce the deficit and force tax rates to be higher to obtain a given amount of revenue; (4) greater scrutiny of tax expenditures could be achieved by strengthening techniques currently used to control tax expenditures; (5) Congress could further integrate tax expenditures into the budget process by deciding whether savings in tax expenditures are desirable and setting specific savings targets in annual budget resolutions; and (6) reviews of tax expenditures could be integrated with functionally related outlay programs, which could make the government's overall funding effort more efficient.

Matters for Congressional Consideration

  1. Status: Closed - Not Implemented

    Comments: Although tax expenditures should be reexamined with the same scrutiny as spending programs, Congress has not taken action to integrate tax expenditures into current budget processes. Because tax expenditures are less visible in the budget, there is an incentive for policymakers to use tax provisions rather than spending programs to accomplish programmatic ends. However, both have a negative effect on the government's "bottom-line." Annual reporting is a key first step in providing the public and policymakers with perspective on the numbers of tax expenditures and the associated revenue losses. Each year the Joint Committee on Taxation (JCT) publishes a tax expenditure report on for the House Committee on Ways and Means and the Senate Committee on Finance. The report also is submitted to the House and Senate Committees on Budget. In May 2008, JCT introduced a new approach for classifying tax expenditures into two broad categories' tax subsidies or tax-induced structural distortions. According to JCT, the new approach is to provide a more effective and neutral tool for policymakers to evaluate existing tax expenditures and new legislative proposals. In October 2008, JCT issued its annual tax expenditure report using the new framework.

    Matter: Should Congress wish to consider tax expenditure efforts in a broader context of the allocation of federal resources, it could consider further integrating them into current budget processes. Providing for congressional consideration of a savings target as part of the annual budget process could ensure that Congress addresses tax expenditures periodically. Alternatively, options to integrate consideration of related outlay and tax expenditure efforts could promote a more thorough review by the legislative and executive branches of alternatives to achieving federal objectives.

  2. Status: Closed - Implemented

    Comments: Congress recently has subjected several tax expenditures to close examination. The Small Business Job Protection Act of 1996 repealed the possessions tax credit (after a phaseout period). Congressional committees also called for GAO evaluations of the alcohol fuels tax credit, the low income housing tax credit, and the earned income tax credit. The IRS Restructuring and Reform Act of 1998 modified several existing tax expenditures, including individual retirement accounts, the child tax credit, education credits, and preferential capital gains tax rates.

    Matter: The tax-writing committees should explore, within the existing framework, opportunities to exercise more scrutiny over indirect spending through tax expenditures.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: The Treasury Department is deferring to OMB on this recommendation.

    Recommendation: The Director, Office of Management and Budget (OMB), in consultation with the Secretary of the Treasury, should revise the budgetary presentation of tax expenditure information to highlight for the public and policymakers the fiscal and other consequences associated with tax expenditures. A revised presentation should include the combined federal resources allocated in functional areas, including both outlays and tax expenditures and, to the extent possible, information that could be used in assessing their effectiveness, distributional equity, and economic efficiency.

    Agency Affected: Department of the Treasury

  2. Status: Closed - Not Implemented

    Comments: As a start in acting on our 1994 recommendations, OMB began presenting revenue loss sums for each budget function in the fiscal year 1998 budget, and these summary tables were a useful starting point in highlighting the relative magnitude of tax expenditures across mission areas. However, OMB discontinued the reporting practice after the fiscal year 2002 budget. In the tax expenditure chapter in the "Analytical Perspectives" volume accompanying the 1997 budget, OMB and the Department of the Treasury added a section outlining possible performance measures which could be used to present information about the performance of tax expenditures, but no performance information has actually been displayed. In September 2005, we recommended that OMB, in consultation with Treasury, resume presenting tax expenditures in the budget together with related outlay programs to show a truer picture of the federal support in a mission area. See "Government Performance and Accountability: Tax Expenditure Represent a Substantial Commitment and Need to Be Reexamined" (GAO-05-690, September 23, 2005).

    Recommendation: The Director, Office of Management and Budget (OMB), in consultation with the Secretary of the Treasury, should revise the budgetary presentation of tax expenditure information to highlight for the public and policymakers the fiscal and other consequences associated with tax expenditures. A revised presentation should include the combined federal resources allocated in functional areas, including both outlays and tax expenditures and, to the extent possible, information that could be used in assessing their effectiveness, distributional equity, and economic efficiency.

    Agency Affected: Department of the Treasury

  3. Status: Closed - Not Implemented

    Comments: Tax expenditures are not subject to annual budget reviews, and OMB has not used its Program Assessment Rating Tool (PART) to systematically review tax expenditures and promote joint and integrated reviews of tax and spending programs sharing common, crosscutting goals. Although OMB plans to assess nearly all remaining Executive Branch spending programs, so far OMB has used PART to address tax expenditures in only two cases and as of July 2005 planned one more tax expenditure review. In September 2005, we recommended that the Director of the Office of Management and Budget (OMB), in consultation with the Secretary of the Treasury, require that tax expenditures be included in the PART process and any future such budget and performance review processes so that tax expenditures are considered along with related outlay programs in determining the adequacy of federal efforts to achieve national objectives. See "Government Performance and Accountability: Tax Expenditure Represent a Substantial Commitment and Need to Be Reexamined" (GAO-05-690, September 23, 2005).

    Recommendation: To the extent that it is practical, OMB should incorporate tax expenditures into the annual budget review process. OMB, consulting as appropriate with the Department of the Treasury and other federal agencies, should use information on outlay programs and tax expenditures to determine and make recommendations to the president and Congress about the most effective methods for accomplishing federal objectives.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  4. Status: Closed - Not Implemented

    Comments: The Treasury Department is deferring to OMB on this recommendation.

    Recommendation: To the extent that it is practical, OMB should incorporate tax expenditures into the annual budget review process. OMB, consulting as appropriate with the Department of the Treasury and other federal agencies, should use information on outlay programs and tax expenditures to determine and make recommendations to the president and Congress about the most effective methods for accomplishing federal objectives.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  5. Status: Closed - Not Implemented

    Comments: The Treasury Department is deferring to OMB on this recommendation.

    Recommendation: OMB, working with Treasury, should design and test the basic structure for tax expenditure performance reviews before OMB develops a framework for governmentwide use by May 1997. This could help ensure that a practical and effective framework is developed for analyzing the effects of tax expenditures in achieving performance goals under the Government Performance and Results Act of 1993. Design considerations should include determining: (1) which tax expenditures and outlay programs are related or interact and, therefore, should be jointly considered; and (2) the roles of OMB, the Department of the Treasury, and departments or agencies with outlay program responsibilities in assessing the performance of tax expenditures and their relationship and interaction with related spending programs.

    Agency Affected: Executive Office of the President: Office of Management and Budget

  6. Status: Closed - Not Implemented

    Comments: The Office of Management and Budget (OMB) outlined an initial framework for tax expenditure analysis in its May 1997 GPRA report to the President and Congress, and in 1997, the Department of the Treasury did three pilot evaluations of selected tax expenditures to test the evaluation methods that OMB had described in its framework. Since their initial efforts to outline an evaluation framework and preliminary performance measures, OMB and Treasury have largely ceased to make progress and have retreated from setting a schedule for evaluating tax expenditures. One of the key impediments to moving forward in conducting reviews of tax expenditures' performance is the continuing lack of clarity about the roles of OMB, Treasury, IRS, and departments or agencies with outlay program responsibilities. In September 2005, we recommended that OMB, in consultation with Treasury, develop and implement a framework for conducting performance reviews of tax expenditures. In developing the framework, (1) determine which agencies will have leadership responsibilities to review tax expenditures, how reviews will be coordinated among agencies with related responsibilities, and how to address the lack of credible performance information on tax expenditures; (2) set a schedule for conducting tax expenditure evaluations; (3) re-establish appropriate methods to test the overall evaluation framework and make improvements as experience is gained; and (4) to identify any additional resources that may be needed for tax expenditure reviews. See "Government Performance and Accountability: Tax Expenditure Represent a Substantial Commitment and Need to Be Reexamined" (GAO-05-690, September 23, 2005).

    Recommendation: OMB, working with Treasury, should design and test the basic structure for tax expenditure performance reviews before OMB develops a framework for governmentwide use by May 1997. This could help ensure that a practical and effective framework is developed for analyzing the effects of tax expenditures in achieving performance goals under the Government Performance and Results Act of 1993. Design considerations should include determining: (1) which tax expenditures and outlay programs are related or interact and, therefore, should be jointly considered; and (2) the roles of OMB, the Department of the Treasury, and departments or agencies with outlay program responsibilities in assessing the performance of tax expenditures and their relationship and interaction with related spending programs.

    Agency Affected: Department of the Treasury

  7. Status: Closed - Not Implemented

    Comments: The Treasury Department is deferring to OMB on this recommendation.

    Recommendation: Once the initial determinations have been made, OMB, along with Treasury, should conduct case studies of the proposed performance review process to, among other things, identify: (1) successful methods agencies devise for reviewing tax expenditures' performance; (2) how best to report the results of these reviews; and (3) how to ensure that adequate resources are available for such reviews. This would enable OMB and Treasury to gauge how well the proposed framework for measuring and reporting on tax expenditure performance might function.

    Agency Affected: Department of the Treasury

  8. Status: Closed - Not Implemented

    Comments: The Office of Management and Budget (OMB) outlined an initial framework for tax expenditure analysis in its May 1997 GPRA report to the President and Congress, and in 1997, the Department of the Treasury did three pilot evaluations of selected tax expenditures to test the evaluation methods that OMB had described in its framework. Although OMB originally expected to complete additional evaluations to refine the tax expenditure framework and improve performance measures, no further pilot evaluations have been completed. In reporting the results of these pilots, Treasury said that much of the data needed for thorough analysis was not available and that in at least one case, it was difficult to identify a clear purpose for the tax expenditure. No schedule has been set for further evaluations or case studies to explore methods and resource needs for measuring and reporting tax expenditure performance. Treasury did not discuss the resources that would be needed to continue doing such evaluations. In September 2005, we recommended that the Director of the Office of Management and Budget (OMB), in consultation with the Secretary of the Treasury, should OMB, in consultation with Treasury, should develop and implement a framework for conducting performance reviews of tax expenditures. In developing the framework, (1) determine which agencies will have leadership responsibilities to review tax expenditures, how reviews will be coordinated among agencies with related responsibilities, and how to address the lack of credible performance information on tax expenditures; (2) set a schedule for conducting tax expenditure evaluations; (3) re-establish appropriate methods to test the overall evaluation framework and make improvements as experience is gained; and (4) to identify any additional resources that may be needed for tax expenditure reviews. See "Government Performance and Accountability: Tax Expenditure Represent a Substantial Commitment and Need to Be Reexamined" (GAO-05-690, September 23, 2005).

    Recommendation: Once the initial determinations have been made, OMB, along with Treasury, should conduct case studies of the proposed performance review process to, among other things, identify: (1) successful methods agencies devise for reviewing tax expenditures' performance; (2) how best to report the results of these reviews; and (3) how to ensure that adequate resources are available for such reviews. This would enable OMB and Treasury to gauge how well the proposed framework for measuring and reporting on tax expenditure performance might function.

    Agency Affected: Congress

  9. Status: Closed - Not Implemented

    Comments: In the tax expenditure chapter in "Analytical Perspectives," the Office of Management and Budget (OMB) added a section outlining possible performance measures developed by Treasury, which could be used to present information about the performance of tax expenditures. Although this overview was initially introduced in the 1997 budget and expanded in the 1999 budget, no performance information is actually displayed. OMB states that the measure examples provided are "illustrative" in nature, acknowledges that the performance measure discussion "although broad, is nonetheless incomplete," and noted that many tax expenditures are not explicitly cited. As we reported in 2005, OMB officials we interviewed reiterated that the data availability issues raised in the Department of the Treasury's three 1997 pilot tax expenditure studies remain a major challenge, and data constraints limit the assessment of the effectiveness of many tax expenditures. OMB reported in the fiscal year 2006 budget that it is working with Treasury's Office of Tax Analysis and other agencies to improve data available for assessment of saving-related tax expenditures. No time frame was given in the 2006 budget for when any results will be reported. See "Government Performance and Accountability: Tax Expenditure Represent a Substantial Commitment and Need to Be Reexamined" (GAO-05-690, September 23, 2005).

    Recommendation: Once tax expenditure performance data are developed, OMB also should consult with Treasury in considering how to portray tax expenditure performance information in the Budget. To complement the intent of the reviews, the tax expenditure performance information should be combined with related outlay information to demonstrate the relative efficiency, effectiveness, and equity of federal outlay and tax expenditure efforts within a functional area. Such a presentation could be used to show the relative effectiveness of federal spending programs funded through both outlays and tax expenditures.

    Agency Affected: Department of the Treasury

  10. Status: Closed - Not Implemented

    Comments: The Treasury Department is deferring to OMB on this recommendation.

    Recommendation: Once tax expenditure performance data are developed, OMB also should consult with Treasury in considering how to portray tax expenditure performance information in the Budget. To complement the intent of the reviews, the tax expenditure performance information should be combined with related outlay information to demonstrate the relative efficiency, effectiveness, and equity of federal outlay and tax expenditure efforts within a functional area. Such a presentation could be used to show the relative effectiveness of federal spending programs funded through both outlays and tax expenditures.

    Agency Affected: Department of the Treasury

 

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