Tax Expenditures and the Budget Deficit

“Tax expenditures” are an opaque form of government spending that operates through the tax code – instead of the government making direct payments to individuals or institutions, tax credits are issued.  In total, they cost the U.S. government about $1.1 trillion annually – roughly equivalent to the country’s enormous budget deficit.

Deficit reduction plans, including Paul Ryan’s Path to Prosperity and Simpson-Bowles, have proposed eliminating tax expenditures as a means of making the tax code simpler and less distortionary. Cutting tax expenditures, however, is politically challenging – in some cases perhaps impossible.  Take, for example, the imputed rental income from which homeowners benefit - that is, the estimated income they would get if they rented out their homes, while living in rental accommodations themselves. Subsidyscope estimates that not taxing this income cost the government $27 billion in FY 2009. But taxing imputed rental income would be brutally hard to sell as an elimination of a distortionary tax break.

Who benefits from tax expenditures?  This varies widely by item.  As seen in the figure above, of the seven precisely measurable tax expenditures worth over $20 billion, three accrue disproportionately to households earning over $200,000 a year.  The largest such is the mortgage interest tax deduction, costing the government over $80 billion a year.  It is less a means of encouraging home ownership than a means of encouraging the well-off to borrow more than they need to buy bigger homes than they need.  American legislators should summon the courage to follow the British example and phase it out.

Ryan: The GOP Budget and America's Future

Video: Erskine Bowles on Deficits

Subsidyscope: Pew's Tax Expenditure Database

The Atlantic: Why the Mortgage Interest Tax Deduction Is Terrible