- 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 (Est. 2018)
- Exclusion of Employer Contributions for Healthcare and Long-Term Care $173 billion
- Reduced Tax Rate on Dividends and Long-term Capital Gains, $136 billion
- Exclusion of Contributions and Earnings, Defined Contribution Plans, $115 billion
- Exclusion of Contributions and Earnings, Defined Benefit Plans, $83 billion
- Deduction of State and Local Taxes, $74 billion
- Deduction for Mortgage Interest, $72 billion
- Child Tax Credit, $54 billion
- Deduction for Charitable Contributions, $44 billion
- Exclusion of Untaxed Social Security and Railroad Retirement Benefits, $42 billion
- Exclusion of Capital Gains on Sales of Principal Residences, $36 billion
10 Largest Corporate Tax Expenditures (Est. 2018)
- Deferral for Active Income of Controlled-Foreign Corporations, $122 billion
- Sec. 179 Expensing of Depreciable Business Property, $18 billion
- Bonus depreciation and general acceleration under MACRS: $18 billion
- Deduction of Income Attributable to Domestic Production Activities: $15 billion
- Deferral of Gains on Like-Kind Exchanges: $12 billion
- Exclusion of Interest on Public Purpose State and Local Government Bonds: $10 billion
- Credit for Increasing Research Activities: $10 billion
- Credit for Low-Income Housing: $9 billion
- Deferral of Gain on Non-Dealer Installment Sales: $7 billion
- Special Treatment of Life Insurance Company Reserves: $3 billion
Resources and Reports