The case against tax expenditures

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There are two obvious ways to reduce the federal deficit (spend less or tax more), and then there’s the really compelling one—stop using the tax code to guide the way people make decisions. Bloomberg recently reported that the President’s debt commission is focusing “a lot” on tax expenditures—the deductions, exemptions and other tax breaks that the government often bestows on individuals and corporations instead of spending money directly. The government passes up about $1 trillion in revenue a year this way.

Why hate on tax expenditures?

Partly because of the particular things the money goes for, like the mortgage interest deduction. As you know, I’m not the world’s biggest fan. If you go to this PDF from the Office of Management and Budget and scroll down to page 220 (table 16-2), you can see a rundown of all the major tax expenditures. They’re ranked in order of amount, which provides a fantastic comparison. The deductibility of mortgage interest is the second largest. For 2011, it is projected to cost the government $105 billion. (Thanks to Teresa Ghilarducci for directing me to this table.)

Now, some of these expenditures are probably justified. The largest tax expenditure is the exclusion of employer contributions for health insurance. That comes in at $177 billion for 2011. I’m not necessarily saying we should give companies less incentive to provide health insurance.

But even when tax expenditures are directed toward a good cause, the form is all wrong. As this Government Accountability Office (GAO) report from 2005 points out, since the mid-1970s, the number of tax expenditures has doubled and the amount of revenue lost has tripled (after being corrected for inflation). That’s a whole lot happening outside of the normal debate about what we want to spend money on. Maybe that’s politically expedient, but it doesn’t seem like what we should be shooting for transparency-wise.

In fact, for years the GAO has held that the foggy system under which tax expenditures come to be should be fixed. From the 2005 report:

Over the past decade… the Executive Branch made little progress in integrating tax expenditures into the budget presentation, in developing a structure for evaluating tax expenditure outcomes or in incorporating them under review processes that apply to spending programs.

Is this the year?