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The Congressional Budget Office is required by section 308(c) of the Congressional Budget Act of 1974 to issue a report each year that projects tax expenditures for each of the next five fiscal years. This report fulfills that statutory requirement for fiscal years 1982 to 1986. It is a companion to Baseline Budget Projections; Fiscal Years 1982-1986 (July 1981), which gives CBO's projections of budget authority, outlays, and revenues for the same period.
This report also discusses a number of definitional and measurement issues that have arisen with respect to tax expenditures, and reviews some of the economic, jurisdictional, budgetary, and administrative considerations in choosing among tax expenditure subsidies, general tax cuts, and direct expenditure subsidies. It also reviews briefly the legislation affecting tax expenditures enacted in calendar years 1980 and 1981, including the Economic Recovery Tax Act of 1981. The five-year projections of revenue losses from tax expenditures in Appendix A do not include the effects of that act, however; they reflect the law in effect on January 1, 1981.
The report was prepared by James M. Verdier of the Tax Analysis Division,
with assistance from Ralph Rector, Willie Bradford, and Martha Campbell.
All members of the Tax Analysis Division provided valuable comments and
suggestions. A number of others both inside and outside of the CBO made
detailed comments on earlier drafts, including Henry Aaron, Albert Buckberg,
Sheldon S. Cohen, Seymour Fiekowsky, Alfred B. Fitt, Jerome Kurtz, Paul
R. McDaniel, Joseph A. Pechman, Allen Schick, Mark Steitz, Emil M. Sunley,
Stanley S. Surrey, and Paul Van de Water. Patricia H. Johnston edited the
manuscript, and Linda Brockman typed it.
Alice M. Rivlin
Director
September 1981
SUMMARY
CHAPTER I. INTRODUCTION
CHAPTER II. MEASUREMENT OF TAX EXPENDITURES
CHAPTER III. TAX EXPENDITURE SUBSIDIES, GENERAL TAX CUTS, AND DIRECT EXPENDITURE SUBSIDIES
CHAPTER IV. CHANGES IN TAX EXPENDITURES ENACTED IN 1980 AND
APPENDIX A. TAX EXPENDITURE ESTIMATES BY FUNCTION AND SUBFUNCTION, FISCAL YEARS 1981-1986
APPENDIX B. TAX EXPENDITURES BY CONGRESSIONAL COMMITTEE WITH AUTHORIZING
JURISDICTION OVER RELATED DIRECT OUTLAYS
| TABLES | |
| 1. | TAX EXPENDITURE ESTIMATES BY FUNCTION AND SUBFUNCTION, CALENDAR YEARS 1967-1973 AND FISCAL YEARS 1974-1986 |
| 2. | CHANGES IN THE TAX EXPENDITURE BUDGET, FISCAL YEARS 1967 TO 1986 |
| 3. | HOUSING AND ENERGY TAX EXPENDITURES AND OUTLAY EQUIVALENTS, FISCAL YEARS 1980-1982 |
| 4. | NEW TAX EXPENDITURES WITH EXPIRATION DATES AND/OR STUDY REQUIREMENTS ENACTED BETWEEN 1969 AND 1981 |
| 5. | TAX RETURNS WITH SELECTED TAX EXPENDITURES, AS A PERCENTAGE OF TOTAL RETURNS FILED, CALENDAR YEAR 1978 |
| 6. | REVENUE EFFECTS OF CHANGES IN TAX EXPENDITURES IN CALENDAR YEAR 1980 FOR FISCAL YEARS 1981-1985 |
| 7. | REVENUE EFFECTS OF CHANGES IN TAX EXPENDITURES IN THE ECONOMIC RECOVERY TAX ACT OF 1981, FISCAL YEARS 1981-1986 |
| A-1. | TAX EXPENDITURE ESTIMATES BY FUNCTION AN SUBFUNCTION, FISCAL YEARS 1981-1986 |
Tax expenditures are revenue losses that result from provisions of the federal tax code that give special or selective tax relief to certain groups of taxpayers. Like federal spending and loan programs, tax expenditures serve to channel resources from some sectors of the economy to others. The investment tax credit, for example, encourages investment in business plant and equipment by allowing those who make such investments to pay less tax than they otherwise would, while the extra personal exemption for the blind gives special tax relief to this class of taxpayers.
There is occasional uncertainty about whether a particular provision
should be treated as a tax expenditure or not. The general rule is that
provisions that are part of the normal structure of the income tax--general
rate schedules and exemption levels, deductions for the costs of earning
taxable income, and the like--are not tax expenditures; only special provisions
that have some purpose beyond simply defining taxable net income fall into
this category.
MEASUREMENT
Since tax expenditures represent revenue the federal government does not collect, measuring them presents some special conceptual and practical problems. The amount of revenue that would be collected under some different law can never be directly observed. A tax system without tax expenditures is simply an abstraction; it cannot be measured with the same precision that actual outlays and tax collections can.
In addition to this conceptual problem, practical difficulties arise
because of the interaction of the revenue loss estimates of tax expenditures
with the standard deduction (zero bracket amount), marginal tax rates,
and other provisions of the tax code. The estimates for each tax expenditure
are made by assuming that the provision is repealed, that all other provisions
of the tax code are unchanged, and that economic behavior is not affected
by the tax expenditure change. While this is a convenient and useful approach
for estimating the cost of a single tax expenditure, since it corresponds
roughly to the estimates for individual spending programs, it becomes less
realistic as more and more simultaneous changes in tax expenditures are
included in the estimate. The arithmetic total of all tax expenditure revenue
losses thus has only limited value. Nonetheless, the estimates of the revenue
loss from each individual tax expenditure serve well the major purpose
of the tax expenditure budget, which is to compare the costs and benefits
of alternative ways of channeling resources to particular groups or activities.
TAX EXPENDITURE SUBSIDIES, GENERAL TAX CUTS, AND DIRECT EXPENDITURE SUBSIDIES
Since the effects of tax expenditures are very similar to those of federal spending and loan programs, it is useful analytically to consider tax expenditures as alternatives to spending programs. In practice, however, the choice is frequently between changes in tax expenditures and more general tax cuts. Changes in tax expenditures are normally considered in the context of tax legislation, and committee jurisdictional constraints generally limit the extent to which trade-offs between tax expenditures and direct spending programs can be made. Trade-offs between tax expenditures and general tax cuts are more feasible. The size of a general tax cut may be reduced to make room for new or increased tax expenditures, while revenue raised from reducing existing tax expenditures can be used to finance a larger general tax cut.
Tax Expenditures Versus General Tax Cuts
In deciding between tax expenditures and general tax cuts, the choice is generally between relatively large per-taxpayer savings for a narrowly defined group of taxpayers and relatively small per-taxpayer savings for large numbers of taxpayers. More specifically, the choice may turn on the possible effects of alternatives on taxpayer behavior and marginal tax rates.
Proponents of tax expenditures that encourage or reward a certain kind of behavior--targeted savings incentives, for example--frequently argue that such provisions will have greater effects on taxpayer behavior than broad across-the-board tax cuts of the same overall dollar amount. While tax subsidies or incentives that favor a particular kind of economic activity will result in more resources being devoted to that activity, this usually represents a reallocation of existing resources rather than any overall increase in resources. The effects on overall economic activity are likely to be about the same as from a general tax cut of the same size.
Tax expenditures can be viewed as both a cause and an effect of high marginal tax rates. Because tax expenditures remove a large share of income from the tax base, tax rates must be higher on the taxable income that is left to raise the same amount of revenue. And because marginal tax rates often reach quite high levels, there is continual pressure for tax expenditures to shield income from those high rates.
Tax Expenditures Versus Direct Expenditures
Tax subsidies can also serve as alternatives to spending or loan programs. Almost any feature that is included in a spending or loan program can be duplicated in a tax subsidy. There are some practical differences between tax and direct expenditure subsidies, however, that may lead the Congress to choose one rather than another.
Nontaxpayers. It can be difficult to extend tax subsidies to individuals and businesses that do not pay taxes. The most straightforward way of doing so is through the use of "refundable" tax credits--credits that are paid directly in cash to the recipients if they do not have tax liability as large as the credit. The only tax expenditure that is currently refundable is the earned income credit for low-income workers with dependents, but it has frequently been suggested that the investment tax credit and other business tax credits be refundable as well. Another way of extending tax subsidies to nontaxpaying businesses is through leasing arrangements, whereby a business with little or no tax liability leases equipment from a business with enough taxes to use the subsidy. The rules for this arrangement were considerably liberalized in the Economic Recovery Tax Act of 1981.
Experience with the earned income credit suggests that nontaxpaying individuals, especially those with low incomes, can be more difficult to deal with through the tax system than nontaxpaying businesses. The IRS may have no record of the existence of nontaxpaying individuals, and thus cannot easily inform them of their possible eligibility. Many low-income individuals are fearful of the IRS, and may be reluctant to have any association with it. Even if they overcome their reluctance, they may have difficulty with the forms and paperwork necessary to establish their eligibility, and the IRS has relatively few resources to provide them with assistance.
Committee Jurisdictions. Tax expenditures come under the jurisdiction of the tax-writing committees, while most spending programs that might be considered as alternatives come under the jurisdiction of other committees. Although this can make it difficult for the Congress to consider directly trade-offs between tax subsidies and spending programs, the problem can be eased by provisions in both Houses for the joint referral of legislation to two or more committees.
The tax committees sometimes lack expertise in program areas in which tax subsidies are provided. These committees do have jurisdiction over a wide range of health, welfare, Social Security, and unemployment compensation programs, however, and have dealt extensively in recent years with energy issues. Joint referral can also help to make up for a lack of tax committee expertise.
Budgetary Control. Tax expenditures are subject to less precise control in the budget process than are most spending programs. The budget resolutions do not set targets for tax expenditures by budget functional categories, as they do for direct spending programs. Nor are the tax committees allocated target ceilings for tax expenditures, as all committees are in the case of spending programs under their jurisdiction.
Revenue floors -- The budget process does impose one very important constraint on tax expenditures, however. Once an overall revenue floor is established by the second budget resolution, any legislation that would reduce total revenues below the floor is subject to a point of order. This requires that any increases in tax expenditures compete with all other revenue-losing provisions for the limited amount of tax reduction that is permitted. This is not very different from the discipline that applies to spending programs. While the second budget resolution does include limits on spending by major functional category, it is only the overall spending totals that are binding, just as it is only the overall revenue floor that limits tax expenditures.
Visibility -- Each bill increasing or reducing tax expenditures is accompanied by a report giving an estimate of the five-year loss or gain from the change, just as spending bills are accompanied by five-year cost estimates. Changes in tax expenditures have the same effect on the federal deficit as do any other tax or spending changes, and thus receive whatever attention and scrutiny that entails.
Periodic review -- Tax subsidies are not regularly reviewed in the way that spending programs subject to annual appropriations or periodic reauthorizations are. With the growth in recent years of entitlement programs, however, only about half of federal spending is subject to discretionary annual appropriations, and programs that are periodically reauthorized may not receive detailed scrutiny each time. In addition, tax expenditures often come up for review when the Congress considers major tax legislation, which it has done often over the last decade. Some new tax expenditures in recent years have also included scheduled expiration dates and/or required studies of their effectiveness, thereby encouraging periodic review.
Administration
The ease of administration of any subsidy program depends mainly on the eligibility rules and how they are enforced. If the rules are clear and simple, if the information needed to verify eligibility can be easily obtained, and if no significant exercise of judgment is required to apply the rules, administration of the subsidy is easy. The more a program departs from these conditions, the harder it is to administer. Tax subsidies are not different from other subsidies in this respect.
For programs that fall into the easy-to-administer category, there are some advantages in using the IRS as a subsidy distribution mechanism. It is a well-run bureaucracy that deals annually with nearly 100 million taxpayers. It already has much of the information on income, family size, and other characteristics that may be used to determine eligibility, and it can make spot checks through its system of audits.
Only about 2 percent of returns are audited, however, and many subsidy programs have eligibility rules that rely on information that tax auditors rarely check. If, therefore, the Congress wants to keep fairly close watch on eligibility for a subsidy program, providing the subsidy through the tax system may not be the best approach. But if the Congress determines that the costs of detailed eligibility checks for a particular program are likely to be greater than the losses from payments to ineligible recipients, the tax system may be preferable to setting up a new or expanded bureaucracy to administer a direct spending subsidy.
A major drawback to using the IRS as a subsidy distribution agency is that it can impose a significant burden of extra complexity on both taxpayers and the IRS. With IRS resources already severely strained by frequent changes in tax legislation, expanding tax shelter activities, and apparently widespread tax evasion in the so-called "underground economy," the extra burden of running multiple subsidy programs could lead to administrative breakdowns.
Another consideration in having the IRS administer a subsidy program is that the IRS is not likely to be as sympathetic to the goals of the program as an agency with jurisdiction over analogous direct spending programs might be. When the IRS is assigned the task of administering subsidies for housing, employment, home insulation, preservation of historic buildings, local economic development, and the like, the usual response is to treat the subsidies as if they were normal tax provisions rather than subsidy programs. Eligibility is restricted as narrowly as possible, consistent with the provisions of the statute, in order to minimize the loss of revenue. Little attempt is made to publicize the availability of the subsidy or to promote its use. Attempts to overcome these problems by having tax subsidies jointly administered by the IRS and the agencies responsible for comparable spending programs are often bogged down by interagency conflicts over eligibility rules and administrative procedures.
Beneficiary Perceptions and Preferences
The beneficiaries of a tax subsidy usually prefer not to think of the tax savings they receive as a subsidy, but rather as something that results from a normal feature of the tax code. If there is likely to be subtantial reluctance to take advantage of a subsidy--as seems to be the case with the present targeted jobs tax credit--having it work as much like a normal provision of the tax code as possible could encourage more widespread use.
Beneficiaries may also prefer receiving subsidies through the tax code because they may believe that the subsidies will be more stable and predictable than direct spending subsidies. While it is generally true that tax subsidies are less subject to changes, cutbacks, and delays in funding than federal spending programs, they are not immune from this kind of unpredictability. The legislative and administrative rules for various tax shelter and tax-exempt bond subsidies, for example, have been continually changed and tightened in recent years.
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