Why Are the Feds Giving $900 Billion in Tax Breaks Every Year?

With April 15 upon us, I’d like to talk about taxes. Not about the part of the tax code that generates revenues. You’ve already heard enough about the taxes you pay to last a lifetime, and the election campaign has just begun. Instead, I’ll focus on the less visited topic of the taxes we don’t pay, the part of the tax code that reduces revenues.

Budget officials call these tax expenditures. The rest of us call them tax breaks. They play the same role in government balance sheets as derivatives play in corporate balance sheets.  They hide risks and cover up potential losses and deficits.  In 2006, the Treasury Department identified over $900 billion in tax expenditures, about equal to all discretionary spending by the federal government that year.  Put another way, we lose almost as much money from federal tax breaks each year as we generate in federal income taxes.

This is a huge sum.  Yet we hear little about it.   That needs to change for at least two reasons.  One is that the vast majority of current tax breaks are destructive.  The other is that this harm can be easily alleviated, if we have the political will. 

But before I get to the solution, let me describe the problem.  

The current state of affairs

Tax breaks as currently designed are fundamentally unjust. A $1,000 tax deduction might be worth $400 to a wealthy household in the 40 percent tax bracket, $200 to a middle-income household in the 20 percent tax bracket, and nothing at all to a family that pays no income taxes.  (Keep in mind that almost 40 percent of all U.S. households have no income tax liability.)

Tax breaks are justified as encouraging socially beneficial behavior, such as buying a home, going to school, expanding renewable energy.  But since they reward the rich far more than the middle class or the poor, they are based on the bizarre and nonsensical presumption that the rich have a higher propensity to engage in socially beneficial behavior.  If you want to simply test this proposition, ask any waitress or waiter who tips them better -- the wealthy or the working class. 

Michael P. Ettlinger, vice president for economic policy at the Center American Progress has pointed out the absurdity of current tax breaks that results from their being off budget by using the example of the tax deduction for the blind.  It is of most benefit to a rich blind person and of no value to a poor blind person.  As Ettlinger notes, it’s hard to imagine that a direct spending program based on the assumption that rich blind people are more deserving than those with more modest means would pass the smell test.

But tax breaks avoid the scrutiny given to direct spending programs because they are not part of the regular authorization and appropriations process. This may be why they have proven such a popular source of funding for big business. As the Congressional Budget Office has noted, "The federal government's efforts to promote business are heavily weighted toward tax preferences, with spending and credit programs accounting for a smaller share of federal efforts." Robert S. McIntyre, director of the Citizens for Tax Justice (CTJ) has observed, the total cost of business tax preferences, including those that benefit business investors or subsidize business products far outweighs direct spending on business subsidies. 

The stealth of tax expenditures is evidenced by the fact that even as state legislatures desperately try to balance their budgets, tax breaks continue to expand.  The Massachusetts Budget and Policy Center (MBPC) notes that spending in that state dropped by almost three percent but business tax breaks rose by over four percent.