Friday, May 7, 2010

The Hidden Expenditures: Tax Expenditures

Tax expenditures are about $1 trillion or more annually, approximately equal to all discretionary spending, although it’s difficult to estimate the exact cost because of how these provisions interact with one other.[1] It is difficult to link a specific tax expenditure such as the home mortgage interest deduction to a specific expenditure function because the function of this tax expenditure is to incentivize home ownership. Tax expenditures are a real issue for many states in that they reduce state revenue and have the propensity to cost the state hundreds of millions of dollars yearly. Deductions and exclusions accounted for more than 80 percent of the major individual income tax expenditures federally in 2008 (see figure 1). However, the use of refundable tax credits has increased over time, primarily because of the growth of the earned income tax credit (EITC) (see figure 2)[2].

The other issue with tax expenditures is that they are difficult to assess because they are written into the tax code and thus they don’t get assessed for their costs and benefits with each budget cycle. Many states attempt to bring transparency and clarity to tax expenditures by publishing a tax expenditure report. These reports can help to bring public attention to tax expenditures and what they incentivize. A majority of states produce tax expenditure reports, but eight states do not publish a report: Alabama, Alaska, Georgia, Indiana, Nevada, New Mexico, South Dakota, and Wyoming

Essentially, tax expenditures are a form of spending by the state because they cost states money in a similar way to direct spending. Tax expenditures are different from direct spending in that “direct spending continues only if funds are appropriated for each budget, but the continuation of a tax expenditure does not require legislative action[4]” thus a tax exception continues indefinitely unless there is a specific provision in the tax expenditure that sets an expiration date. Tax expenditures also differ from direct spending in that “direct spending programs are itemized on the expenditure side of the budget, tax expenditures are reflected on the revenue side of the budget and are not itemized.[5] But not every tax exemption, deduction, credit or lower tax rate is a tax expenditure[6]. For the State of Minnesota, tax expenditures must meet all seven criteria to be considered a tax expenditure. These seven criteria are:

􀂾 has an impact on a tax that is applied statewide;

􀂾 confers preferential treatment;

􀂾 results in reduced tax revenue in the applicable fiscal years;

􀂾 is not included as an expenditure item in the state budget;

􀂾 is included in the defined tax base for that tax;

􀂾 is not subject to an alternative tax; and

􀂾 can be amended or repealed by a change in state law.[7]

Tax expenditures make up a surprising amount of state and federal budgets, according to a policy brief published by the Center on Budget Policy and Priorities (CBPP) tax expenditures accounted for $760.5 billion in 2007, compared to $549 billion for national defense spending and $493 billion for non-defense discretionary spending.[8] With tax expenditures making up such a large share of federal and state budgets it is important to continue to dissect
who these tax expenditure’s affect and benefit. According to the Tax Policy Center, tax expenditures for the top quintile are nearly double the income of those in the bottom quintile[9]. This suggests that tax expenditures as a whole are regressive and are mostly benefiting those that may not really need the tax breaks and under-serving those that may really need the tax breaks. According to the Minnesota Tax Expenditure Budget Report, the highest Minnesota subtractions from tax expenditures comes from K-12 Education Expenses, roughly $14,300,000 in 2010 to $14,800,000 in 2013.[10] The highest tax expenditure credits come from the Working Family Credit, $179,800,000 in 2010 to $182,400,000 in 2013.[11] These tax exemptions pale in comparison to deduction of mortgage interest on owner-occupied homes federally which accounts for $573 billon and exclusion of employer contributions for health care and health insurance premiums; $568 billion[12].

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