If you follow discussions about tax policy that academics and politicians engage in, sooner or later you’ll come across the concept of a “tax expenditure.” The term seems internally contradictory. How could something be both a tax and an expenditure?
It can’t. The term is contradictory. And thinking in terms of tax expenditures can lead you to some strange conclusions.
These are the opening paragraphs of David R. Henderson, “The Bizarre Economics of ‘Tax Expenditures‘”, TaxBytes, Institute for Policy Innovation, August 29, 2023.
I use a numerical example with the deduction for home mortgages. I chose that on purpose because I think there should not be a deduction for interest on a home mortgage. But that doesn’t mean that using the term “tax expenditure” to refer to the deduction is a legitimate use of language.
I go on to point out some implications of using the term “tax expenditure” to describe the home mortgage deduction.
Here’s one:
Similarly, raising his tax rate would increase the tax expenditure. And then tax policy wonks would say that he benefited hugely from the tax expenditure even though the higher tax rate made him worse off.
Read the whole thing, which is not long.
READER COMMENTS
robc
Aug 31 2023 at 8:55am
On the original 1913 income tax form, there was a deduction for ALL interest, not just mortgage interest.
Why? To avoid double taxation, of course, as the recipient of the interest was paying income tax on it.
robc
Aug 31 2023 at 9:00am
Looking at old forms shows the way things have changed in society in general.
There were only 6 deductions. #2 was the interest deduction. #4 was uninsured losses due to fire, storm, or shipwreck.
vince
Aug 31 2023 at 2:45pm
If interest was all about avoiding double taxation, why would double taxation on other household expenditures be allowed? Banking lobby?
Thomas L Hutcheson
Aug 31 2023 at 10:03am
I do not like “deductions” at all a a way of favoring certain kinds of expenditure like mortgage interest or charitable giving. If it is worth encouraging, it should be done with a partial tax credit.
Scott Sumner
Aug 31 2023 at 12:28pm
I don’t see a clear distinction between tax breaks and government expenditures. Consider the following two policy options:
A new welfare program that gives everyone a $1000 check.
A new $1000 tax credit that is available to taxpayers, plus a $1000 check paid to non taxpayers.
They have identical effects—right? But in official budget terms one is simply “more G”, and the other is mostly “lower T”.
TMC
Aug 31 2023 at 12:38pm
As a landlord, I deduct the interest on my rental mortgage. If markets are efficient, this gets passed along to renters. Deducting my home mortgage puts me on equal footing as renters.
Thomas L Hutcheson
Sep 3 2023 at 10:36am
Not really. You do not pay income tax on the implicit rent value of occupying your home.
TMC
Sep 5 2023 at 4:08pm
That’s because implicit rent is BS. I also don’t rent my paid off truck.
johnson85
Sep 6 2023 at 11:32am
But if you are a landlord, you do pay taxes on the rental income.
I don’t have a problem with the mortgage interest deduction in principle, but I think as a practical matter all it does is sucker people into buying more house than they should. If you did away with it, it would very slightly sting existing home owners but generally be fine.
I have a bigger issue with allowing corporations to deduct interest on debt but not deduct dividend payments. Seems crazy to me to heavily favor debt financing over equity. I’d even be fine with treating dividends as ordinary income to get there, even though that would be inefficient and unfair.
steve
Aug 31 2023 at 1:04pm
My cynical side always thought calling them tax expenditures was chosen as it was confusing enough for most people to make it easier to give money to preferred special interest groups. Following on Scott’s point I think the common practice of giving tax breaks to some businesses that you dont give to others is also pretty much the same as selecting winners and giving them money but its disguised by calling it pro-business.
Steve
Jim Glass
Sep 1 2023 at 10:08pm
There’s nothing “cynical” about noting the truth — as long as we remember that our most preferred special interest group is “us”. (Is that too cynical?)
The biggest tax expenditures are sent right to the upper-middle class: 1) employer-sponsored health plans, 2) tax reduction on dividends and capital gains, 3) 401(k) plans, 4) credit for children & dependents, 5) employer pension plans…
Well, this much is true: If Gimme Corp gets a $100x cash subsidy from the government it can expect to be derided in some quarters as porking out on the fat of big government at taxpayers’ expense. Bad PR.
Say that then its lobbyist and Congressman meet and agree to change the subsidy to a $100x tax break. The result will be the exact same as before, govt assets – $100x and Gimme assets +$100x. Identical. But the public presentation will be so different.
Now Gimme can change its name to Liberty Corp and say it is simply keeping and spending more of its own money. The former deriders now cheer, yes! this is how to shrink the size of government! PR success! With the situation identical to before. Isn’t psychology fun?
Vivian Darkbloom
Sep 2 2023 at 4:02am
If you really want to be cynical and/or point out “illegitimate use of language”, why not refer to them as “loopholes” which is what those “tax expenditures” are when they don’t benefit you personally. My personal favorite is when a member of Congress uses that term. It’s as if the results of those legislated tax rules were entirely unintentional!
vince
Aug 31 2023 at 2:52pm
It sort of goes back to the perverse notion that tax revenue inherently belongs to the government and not the person who received the taxable income.
Vivian Darkbloom
Aug 31 2023 at 5:18pm
How does this compare with an economist’s use of the term « marginal tax rate »? For example, if the government increases a means tested benefit (spending) does that mean that one’s (potential) marginal tax rate goes up?
The game of semantics is fun!
https://www.econlib.org/archives/2009/09/casey_mulligan.html
Jim Glass
Sep 1 2023 at 9:26pm
How could something be both a tax and an expenditure?
It can’t, obviously. But a tax cut can be an expenditure, definitionally.
The government transfers $100x to Entity by giving it either $100x cash or a tax credit worth $100x — which reduces tax collected from it in that amount. The economic result is the same either way, assets on the balance sheet of the govt: -$100x; on that of Entity: +$100x. Identical. Moving assets of $100x from one party to another is a transfer, in budget terms it is an “expenditure”. The two methods of expenditure are distinguished as “cash” (conventional, ordinary) or “tax” – but whichever way it is done, the economic results of the expenditure are identical.
Why do they call it a tax expenditure? Because their implicit assumption is that there shouldn’t be a deduction for…
This seems very unlikely, being that “the tax expenditure budget”, which annually accounts for all tax expenditures, was mandated by the Congressional Budget Act of 1974 — and presumably Congress favors all the tax expenditures it creates and continues. Nah, there is no value judgment involved.
The tax expenditure budget is a tool of federal accounting. Being that tax expenditures are so massive in amount, equaling total federal discretional spending, such as the defense budget, etc., to omit them from the federal budget numbers, geeze … even Congress couldn’t bring itself to sink that low.
To understand federal fiscal policy and politics one really has to be familiar with them. Take a look at the list of the biggest. Say you want to get a quick take on “who owns Congress and runs the government, by who collects the most billions of dollars through tax expenditures”. A fast glance shows it’s not the “top 1%”, who don’t exist in sufficient number and are income-or-dollar limited out of most of these. Nor is it the lower half of the population by income, as they don’t pay enough tax to benefit from most tax breaks (a few exceptions like the EIC aside). It’s the upper middle class who rule. (Hey, is that us?)
Or say that with the massive national debt-deficits coming to us in the 2030s, you want to see the choices available for closing them. The options are tax increases, cash expenditure cuts, and tax expenditure cuts. When the day comes, remember that these specific items are on the list.
The tax expenditure budget is just an accounting exercise. But accounting matters. A lot.
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