Tax Expenditures: What are the largest tax expenditures?

Tax expenditures make up a substantial part of the federal budget. Some of them are larger than the entire budgets of the programs or departments that spend money for the same or related purposes; for example, the value of the tax breaks for homeownership exceeds total spending by the Department of Housing and Urban Development.

• The largest tax expenditure is the exclusion of employers’ contributions for their employees’ medical insurance premiums and medical care. Under this provision, contributions are excluded from the employee’s gross income, while the employer may deduct the cost as a business expense.
• The next-largest tax expenditure is the combined net exclusion of contributions to and earnings of employer-provided and individual pension plans. These include 401(k) plans, Individual Retirement Accounts (IRAs), the savers’ credit, and Keogh plans. Most of these plans allow taxpayers to exclude employer or individual retirement contributions from their gross income, and to defer taxes on the investment income earned on these savings until the money is withdrawn.
• The deductibility of mortgage interest on owner-occupied homes is one of the three homeownership subsidies that top the list of tax expenditures. Under this provision the mortgage interest paid by owner-occupants of homes may be taken as a nonbusiness deduction, up to a limit.
• The reduced tax rate on capital gains is the fourth-largest tax expenditure. These gains are taxed at a lower rate than ordinary income, provided they are held for more than one year.
• Deductions of charitable contributions to nonprofit educational institutions, nonprofit health institutions, and organizations other than those for education and health are listed as three separate tax expenditures, but deductions for charitable contributions combined would rank as the fifth-largest tax expenditure.
• The deductibility of nonbusiness state and local taxes other than on owner-occupied homes is another large tax expenditure. These taxes are deductible even though they may pay for services received from the state or local government.
• One of the largest tax expenditures for businesses is the provision that allows for accelerated depreciation of certain types of machinery and equipment.
• Homeowners may exclude up to $250,000 ($500,000 for a couple filing jointly) of capital gains on the sale of their principal residence. This is the second-largest homeownership tax subsidy.
• Taxpayers with one or more children under age 17 qualify for a partially refundable child credit of $1,000 per child. Only the nonrefundable portion of the credit is counted as a tax expenditure; any refundable portion is considered an outlay.
• The step-up in basis of capital gains precludes assets from being taxed on any gains accrued, but not realized, at the death of the owner. If the estate tax remains repealed in 2010, some heirs will no longer benefit from this provision.
• Homeowners may exclude from their income the implicit rental value of both their primary residences and vacation homes (imputed rent), net of mortgage interest and depreciation. Homeowners with equity in their home thus pay less tax on the returns from that investment than someone who holds an equivalent amount of assets in a savings account or other taxable investment.