Tax Expenditures: How have they changed over time?
Tax expenditures have shifted dramatically over time. With the important exception of the Tax Reform Act of 1986, recent decades have seen an increase in the number, and sometimes the value, of tax expenditures. At the same time there has been a rise in social tax expenditures and a decline in business tax expenditures, again due mainly to the 1986 act. Tax expenditures also vary in value with tax rates: when rates rise, so do the tax savings associated with many of the deductions and exclusions that make up a large part of the tax expenditure budget.
- Aggregate tax expenditures reported by the Treasury increased between 1976 and 1985 from 5.2 percent to 8.3 percent of GDP. (Because of their interactions, individual tax expenditures do not, strictly speaking, sum to their total cost, but the summation of Treasury numbers still provides a reasonable approximation of their aggregate effect.) They dropped sharply after the tax reform of 1986, falling to near 1976 levels, and rose gradually thereafter, peaking in 2001 at 7.4 percent. (The Treasury first began estimating tax expenditures in 1974; estimates from that year included tax expenditures for 1974-76.) They have stayed within a percentage point of 7 percent of GDP since 1999.
- In the 1970s many tax subsidies were provided as business tax breaks and deductions, which higher-income taxpayers found more valuable. The 1986 tax reform significantly cut back on business preferences, particularly through removal of the investment credit. Only a few social tax expenditures have been removed over time, although their value often fluctuated as tax rates rose or fell.
- Nonbusiness tax expenditures-those reported on individual income tax returns that do not also benefit businesses-are higher in 2006 than in 1976 (see figure).
- Exclusions that exempt specific kinds of income from tax constitute a substantial share of tax expenditures. Many exclusions benefit a large percentage of the population, including much of the middle class. Between 1948 and 1982 exclusions doubled, from 12 percent of personal income to 24 percent, before falling off to 19 percent in 2004. Employer contributions to health plans, Social Security benefits, and tax breaks associated with homeownership are the largest exclusions from income taxation.
- Tax credits have grown significantly since 1986. The expanded use of the earned income tax credit, child tax credits, and other tax benefits targeted toward lower-income families, especially those with children, drove much of this rise. The earned income tax credit and the child credit are refundable and thus provide benefits for many families who owe no income tax.
- The tax expenditure budget ignores the costs of complexity-the time and money costs of claiming credits and deductions on tax returns and the cost of finding and implementing strategies to minimize taxes. But taxpayers today can use software to prepare their returns, which makes it politically more feasible for Congress to add layers of tax complexity without incurring as much taxpayer wrath.