- Tax expenditures are reductions in tax liabilities that result from
- excluding or exempting items from gross income (“tax exclusions”);
- deducting items from either gross income or adjusted gross income (“tax deductions”);
- granting preferential tax rates for certain items of income (“tax preferences”);
- applying credits to directly reduce taxes owed (“tax credits”); or
- deferring tax liability on certain types of income (“tax deferrals”).
- In the context of budgeting, these are collectively referred to as “tax expenditures” because the government foregoes revenues it would have otherwise collected. (Colloquially, they are often referred to as “tax preferences” and “tax breaks”—or as “tax loopholes” by those who disagree with particular provisions.)
- In effect, tax expenditures are “spending on the revenue side” of the budget because policymakers have written into the Tax Code provisions that reduce Federal taxes in order to achieve specific policy outcomes such as encouraging home ownership, financing post-secondary education, assisting a particular industry, or stimulating research and development.
- Tax expenditures may also be viewed as the revenue equivalent of spending entitlements. For example, just as Americans 65 and older are legally entitled to Medicare hospital insurance benefits (on the spending side of the Federal Budget), employees who receive health insurance from their employers are entitled to exclude the employer-paid premiums from their gross income.
- In both examples, eligible individuals are legally entitled to specific benefits—one on the spending side of the budget, the other on the revenue (tax) side.
- The aggregate dollar amount of tax expenditures is about $1.3 trillion — considerably more than total discretionary spending.
- As with spending programs, one cannot generalize about tax expenditures. Tax expenditures are as varied in purpose and operation as programs on the spending side of the budget. Following are five key reports on tax expenditures.
10 Largest Individual Tax Expenditures in 2014
- Exclusion of Employer Contributions for Healthcare, $143 billion
- Reduced Tax Rate on Dividends and Long-term Capital Gains, $96.5 billion
- Exclusion of Contributions to and Earnings from Retirement Plans, $89 billion
- Earned Income Tax Credit, $69 billion
- Deduction for Mortgage Interest, $$68 billion
- Child Tax Credit, $57 billion
- Deduction of State and Local Taxes, $56.5 billion
- Exclusion of Untaxed Social Security and Railroad Retirement Benefits, $37 billion
- Deduction for Charitable Contributions, $35 billion
- Exclusion of Benefits Provided under Cafeteria Plans, $35 billion
10 Largest Corporate Tax Expenditures in 2014
- Deferral for Active Income of Controlled-Foreign Corporations, $83 billion
- Depreciation of Equipment in Excess of the Alternative Depreciation System, Excluding Bonus Depreciation, $24 billion
- Deduction of Income Attributable to Domestic Production Activities: $12 billion
- Deferral of Gains on Like-Kind Exchanges: $12 billion
- Exclusion of Interest on Public Purpose State and Local Government Bonds: $9 billion
- Deferral of Gain on Non-Dealer Installment Sales: $7 billion
- Credit for Low-Income Housing: $7 billion
- Credit for Increasing Research Activities: $4.6 billion
- Reduced Rates on first $10 million of Corporate Taxable Income: $4 billion
- Inventory Peroperty Sales Source Rule Exception: $3 billion
Resources and Reports