How Big Are Total Individual Income Tax Expenditures, and Who Benefits from Them?

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Abstract

Analysts often add up tax expenditures to estimate an aggregate cost, but those tallies are inaccurate because they ignore interactions among provisions. We estimate that interactions raise the cost of nonbusiness tax expenditures by 5 to 8 percent, depending on whether an AMT patch is in effect. In 2007, these tax expenditures totaled about $750 billion - 5.5 percent of GDP. While tax expenditures benefit taxpayers in all income groups, high-income households gain more relative to income than low-income ones. Although the AMT eliminates some tax preferences, it increases overall tax expenditures because most AMT taxpayers face higher marginal tax rates.

Introduction

Stanley S. Surrey coined the term "tax expenditure" when, as assistant secretary of the U.S. Treasury for tax policy in the 1960s, he instructed his staff to compile a list of preferences and concessions in the income tax and estimate their revenue costs. His goals were to focus attention on those tax provisions that were effectively disguised expenditures and to build momentum for a tax reform based on a broad-based income tax (Joint Committee on Taxation 2008; Shaviro 2007; Toder 2005).

Both the Office of Management and Budget (OMB 2008) in its budget presentation and the Joint Committee on Taxation (JCT 2007) compile annual lists of tax expenditures, defined as deviations from the "normal" individual and corporate income tax bases. Until 2002, the budget also included a list of tax expenditures against a transfer tax (estate and gift taxes) baseline, but the fiscal year 2003 and subsequent budgets excluded those items because "there is no generally accepted normal baseline for transfer taxes and.. [the tax was]..repealed under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)" (OMB 2002, 95). In principle, tax expenditures could also be defined with respect to other taxes, such as excise taxes, but that has not been done systematically (Davie 1994).

Among the most critical issues in measuring tax expenditures is the appropriate baseline against which to measure deviations. Surrey's "normal tax" is a comprehensive Haig-Simons-type income tax adjusted to account for administrative realities. On administrative grounds, for example, the baseline taxation of capital gains is on a realization rather than an accrual basis. Income and expenses are not indexed for inflation. More fundamentally, some argue that the baseline might more appropriately eliminate the double taxation of corporate income or even be based on a comprehensive consumption tax, rather than an income tax.

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