US Study Evaluates Cuts In Tax Expenditures
15 July 2013
Posted by: Author: Mike Godfrey
Author: Mike Godfrey
A paper issued by the Urban-Brookings Tax Policy Center (TPC) has evaluated approaches to tax reform that would achieve across-the-board reductions to a group of major exclusions and deductions in the United States individual income tax code.
The paper discusses the issues of designing, implementing and administrating, and simulating the revenue, distributional and incentive effects, of six options on tax expenditures – limiting their tax benefit to a maximum percentage of income; imposing a fixed dollar cap; reducing them by fixed-percentage amount; limiting their tax saving to a maximum percentage of their dollar value; replacing them with fixed rate refundable credits; and including them in the base of the existing Alternative Minimum Tax (AMT).
It is firstly recorded that tax expenditures are defined in the Congressional Budget Act of 1974 as "revenue losses attributable to provisions of the federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability."
The most recent report from the Joint Committee on Taxation listed more than 200 separate tax expenditures, which accounted for over USD1 trillion in lost revenue. The single largest tax expenditure was the exclusion of employer provided health benefits, which will reduce federal income tax revenues by more than USD750bn between 2013 and 2017, followed by the net exclusion of employer-based retirement benefits and the preferential tax rates applied to qualified dividend income and long-term capital gains.
The itemized deductions for state and local taxes (income, sales, personal property and real estate taxes) and mortgage interest completed the top five, and, in total, the top 20 preferences account for roughly 90 percent of all individual income tax expenditures.
It has also been found that tax expenditures benefit taxpayers at all income levels, but on average the benefits are higher as a share of income for upper-income taxpayer than for lower-income taxpayers. The top income quintile accounts for nearly all the tax benefits from preferential treatment of capital gains and dividends, 80 percent of the benefits of itemized deductions, and two-thirds of the benefits from exclusions (including investment income earned within tax-preferred retirement accounts).
The TPC points out that, although both US political parties have endorsed the concept of reforming the tax system by reducing special tax preferences, neither specify what tax preferences they would remove to meet their revenue targets and they also differ on how the additional revenue so raised would be used.
It notes, however, that there has been increasing interest in proposals to provide across the board cuts in tax expenditures, without singling out specific provisions. President Obama has proposed to limit the value of certain tax deductions and exclusions to 28 percent of the deduction or exclusion amount, while the current income tax code already has some broad limitations – the AMT and the Pease overall limitation on itemized deductions.
In examining the six options for providing across the board cutbacks in tax expenditures, the TPC finds that they differ substantially in their effects on both income distribution and incentives to use deductions and exclusions such as the charitable deduction, if it is subject to the limits.
For example, fixed dollar limits and broadening the base of the AMT are discovered to be the most progressive ways of reducing tax expenditures, while a proportional cutback, or haircut, in preferences and a fixed percentage of adjusted gross income (AGI) limit are the least progressive options. The fixed dollar cap and the percent of AGI limit produce the largest reductions in the incentive to give to charity, with the former virtually eliminating any tax incentive for the very highest-income taxpayers.
In conclusion, however, the TPC agrees that across the board limitations of tax expenditures are inferior to policies that address each tax expenditure provision on its merits, but feels that these policies may be the most politically feasible way of cutting back on tax preferences.