The ‘tax expenditure’ solution for our national debt

While most critics of government spending focus on entitlements, regular appropriations, and earmarks, there is a category of spending that not many pay much attention to. The spending is called “tax expenditures.”

It’s a big issue. As economist Martin Feldstein writes in the Wall Street Journal, tax expenditures will increase the federal budget deficit by $1 trillion this year.

Tax expenditures are implemented through the tax system. It’s usually the income tax system, especially at the federal level. Taxpayers may receive tax credits, which reduce the tax that must be paid dollar for dollar. Many credits are refundable, meaning that if the taxpayer has no tax liability, the government will send the recipient a check. Examples cited by Feldstein include “$500 million annual subsidy for the rehabilitation of historic structures and a $4 billion annual subsidy of employer-paid transportation benefits.”

While supporters of many of these programs portray them as not costing the government anything, Feldstein writes that they do: “These tax rules — because they result in the loss of revenue that would otherwise be collected by the government — are equivalent to direct government expenditures.”

I argued this in testimony I presented to a committee in the Kansas Legislature this year, when it was considering restoring and expanding the Kansas historic preservation tax credit program. I told committee members: “We must recognize that a tax credit is an appropriation of Kansans’ money made through the tax system. If the legislature is not comfortable with writing a developer a check for over $1,000,000 — as in the case with one Wichita developer — it should not make a roundabout contribution through the tax system that has the same economic impact on the state’s finances.”

In that committee, not one member voted against this program, even though the committee has some members who consider themselves very fiscally conservative and hawks on spending.

Here in Wichita, the city council regularly steers spending to certain companies through the tax system by granting property tax exemptions and tax increment financing.

Feldstein describes problems with spending implemented through the tax system:

  • Politicians use tax expenditures to grow the welfare state. While proposing a freeze on discretionary spending, President Obama at the same time proposed an expansion of a tax credit program for child or elderly care.
  • Once enshrined in the tax law, these appropriations don’t have to be reauthorized each year. They’re on auto-pilot, so to speak.
  • Eliminating tax expenditures is looked on by Republicans as a tax increase, so they are reluctant to support their elimination. Felstein counters: “But eliminating tax expenditures does not increase marginal tax rates or reduce the reward for saving, investment or risk-taking.”
  • Tax expenditures distort the economy in harmful ways: “[Eliminating tax expenditures] would also increase overall economic efficiency by removing incentives that distort private spending decisions.”

Feldstein concludes: “Cutting tax expenditures is really the best way to reduce government spending. And to be politically acceptable, the cuts in tax expenditures must be widespread, requiring most taxpayers to give up something so that the fiscal deficits can decline.”

The ‘Tax Expenditure’ Solution for Our National Debt

The credits and subsidies that make the tax code so complicated cost big bucks. Reduce them by third and the debt will be 72% of GDP in 2020 instead of 90%.

By Martin Feldstein

When it comes to spending cuts, Congress is looking in the wrong place. Most federal nondefense spending, other than Social Security and Medicare, is now done through special tax rules rather than by direct cash outlays. The rules are used to subsidize a wide range of spending including education, child care, health insurance, and a myriad of other congressional favorites.

These tax rules — because they result in the loss of revenue that would otherwise be collected by the government — are equivalent to direct government expenditures. That’s why tax and budget experts refer to them as “tax expenditures.” This year tax expenditures will raise the federal deficit by about $1 trillion, according to estimates by the congressional Joint Committee on Taxation. If Congress is serious about cutting government spending, it has to go after many of them.

Continue reading at the Wall Street Journal (subscription required)

5 Comments

  • First of all we need to get rid of the income tax system and replace it with something else like the FairTax–that would eliminate the ridiculously complicated tax code, including all these “credits,” and eliminate the IRS. But at the VERY least, no one should get one penny more in taxes “back” than they paid in. That is, people could get their tax credits until they reach zero tax liability, then that’s the end of them, no matter how many credits they have racked up. It infuriates me that anyone could get back MORE than they paid in.

  • Anonymous -

    Not sure I like what you’re saying here it has a similar sound to the leftist charge of “corporate welfare” or “welfare for the rich” often attached to targeted tax cuts or exemptions.

    How far off is this from considering Kansas property tax refunds a handout instead of a tax cut. Not having to pay a tax and getting free government cheese are two different things.

    I would rather see the government continue losing these potential revenue sources, because you know if they had this revenue it would simple be allocated to new spending.

    It may come down to why one fights for conservative economic causes, for fiscal temperance, or to weaken the power of government. Fiscal restraint is fine, but I prefer the latter and so I’m not necessarily concerned who’s getting the tax cut as long as they aren’t paying as much, or aren’t paying at all.

  • Anonymous -

    If the government got the Fair Tax, a national sales tax, implemented the Democrats would just say “thank you, I’ll take that and lets keep the income tax too”. It would just turn out to be a more transparent VAT.

  • Anonymous -

    “In that committee, not one member voted against this program, even though the committee has some members who consider themselves very fiscally conservative and hawks on spending.”

    Ya gotta appreciate those that deal with pragmatic reality versus those that deal in obtuse ideology.

  • Anonymous, I am only in favor of the FairTax as a *replacement* to the income tax. No way would I EVER champion the implementation of the FairTax if it didn’t include doing away with the income tax at the same time. I don’t think anyone who supports the FairTax wants to get it implemented before the income tax is done away with. We know that the creeps in Washington would do just as you said.

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