The federal tax code is riddled with provisions that either reduce or eliminate tax liabilities for businesses or individuals. These provisions, which include a variety of tax credits and deductions, are often called “tax expenditures.”
That’s because these provisions are effectively spending within the tax code. Members of Congress approve them to achieve specific policy goals such as encouraging home ownership, financing post-secondary education, assisting a particular industry, or stimulating research and development.
While many of these goals seem reasonable, it is important to understand the enormous overall impact that tax expenditures have on the federal budget and U.S. economy. In 2016 alone, these tax expenditures cost the U.S. government $1.6 trillion in lost revenue. If tax expenditures were their own category of spending in the federal budget, that category would exceed the size of Social Security and Medicare combined.
Like several spending programs, tax expenditures become entrenched and difficult to reduce or eliminate once enacted. In fact, tax expenditures often receive less legislative and public scrutiny than regular spending programs. Many tax expenditures originated as temporary tax breaks designed to expire after a few years. But lawmakers regularly renewed most (if not all) of these expiring breaks year after year in packages known as “tax extenders.” In 2015, they made several tax extenders permanent – a move that was not offset and is projected to increase deficits by $800 billion over 10 years from their enactment.
Given the nation’s difficult fiscal challenges, reducing tax expenditures merits consideration for possible savings just as much as any spending program does. However, tax expenditures affect not only tax revenue but also who pays taxes and how much. Limiting some of them can increase progressivity in the tax code while limiting others can make the tax code more regressive.
These concerns can be mitigated by doing what many tax reform proposals have called for: eliminating tax expenditures while reducing tax rates (primarily for those at the lower end of the income distribution) to ensure a fairer tax system.