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.
Table 1 ranks the top 13 US tax expenditures. The largest (an estimated $235.8 billion in 2018) is the exclusion of employers’ contributions for employees’ medical insurance premiums and medical care. Under this provision of the tax code, contributions are excluded from an employee’s gross income, while an employer may deduct the cost as a business expense.
The next largest tax expenditure ($112.7 billion in 2018 is the exclusion of net imputed rental income, which is the return on housing equity in the form of rent-free housing. This is one of several tax preferences that focus on housing. Others include the home-mortgage interest deduction ($68.1 billion), the deduction for nonbusiness property taxes as part of the deductibility of nonbusiness state and local taxes ($63.3 billion), and the exemption of the first $500,000 of capital gains for couples ($250,000 for singles) on the sale of principal residences ($48.5 billion).
In general, tax expenditures for individuals are larger than tax expenditures for businesses. Only two business tax expenditure that made it into the list of the top 13: the deferral of income from controlled foreign corporations ($112.6 billion in 2018) and accelerated depreciation of certain machinery and equipment ($50.3 billion in 2018). Among other business tax expenditures, the largest in 2018 are the deduction for US production activities ($17.2 billion), the credit for low-income housing expenditures ($8.9 billion), and the expensing of research and experimentation outlays ($7.7 billion).
Over the 10-year budget horizon, one of the larger tax expenditures is the provision that allows for accelerated depreciation of certain machinery and equipment. This provision allows companies to defer the payment of tax by deducting the cost of equipment over a shorter time period than the property’s likely economic life.
The figures on accelerated depreciation illustrate how computations of annual revenue losses do not accurately measure the amount of subsidy a tax expenditure actually provides when the provision operates mostly by changing the timing of tax liability. For this reason, OMB also publishes a table showing the “present value” of tax benefits from a single year’s use of selected provisions (table 2).
The fourth largest tax expenditure in 2018 is the preferential rate structure for individuals’ capital gains income ($108.6 billion), which is taxed at rates ranging from 0 to 20 percent compared to individual income tax rates that range from 10 to 39.6 percent. Capital gains also benefit from the step up in basis at death ($54.1 billion in 2018), which permanently exempts all unrealized capital gains accrued during an individual’s lifetime on assets that are passed on at death.
Retirement saving also benefits from very large tax expenditures. Investment income earned within tax-qualified saving accounts is tax free. In addition, with most tax-qualified retirement saving accounts, the tax on contributions is deferred until withdrawal at retirement, when a taxpayer is usually in a lower tax bracket. The revenue losses from this preference in 2016 are estimated to total $71.0 billion for “defined-contribution” plans such as individual retirement accounts and 401(k) plans, and $69.4 billion for traditional defined-benefit plans sponsored by employers. In comparison, the present value costs of these provisions from contributions in 2016 are over $82 billion for defined contribution plans and only about $30 billion for defined benefit plans. The differences reflect the switch over time from defined benefit to defined contribution plans, so the present value of the cost of this year’s contributions are relatively smaller for defined benefit plans than their current revenue loss, which reflect revenue losses from assets in older plans.
Two of the largest tax expenditures mainly benefit low- and middle-income families: the earned income credit ($63.6 billion in 2018) and the child credit ($54.3 billion in 2018). Most budgetary costs from these provisions come from the portion of the credits that exceed income tax liability and are counted as spending in federal budget totals.
The Office of Management and Budget (OMB) divides deductions of charitable contributions into three buckets: donations to nonprofit educational institutions, to nonprofit health institutions, and to all other organizations. The third, catch-all category benefits from a $51.2 billion tax expenditure. Combining the deductions for all three categories would raise its ranking in table 1.
US Department of the Treasury, Office of Tax Policy, 2016. Tax Expenditures – FY 2018. Table 3 and table 4.
Burman, Leonard E., Christopher Geissler, and Eric J. Toder. 2008. “How Big Are Total Individual Income Tax Expenditures, and Who Benefits from Them?” Discussion Paper 31 Washington, DC: Urban-Brookings Tax Policy Center.
Marron, Donald, and Eric Toder. 2013. “Tax Policy and the Size of Government.” Washington, DC: Urban-Brookings Tax Policy Center.
Rogers, Allison, and Eric Toder. 2011. “Trends in Tax Expenditures: 1985–2016.” Washington, DC: Urban-Brookings Tax Policy Center.
U.S. Senate Budget Committee. 2008. Tax Expenditures: Compendium of Background Material on Individual Provisions. Washington, DC: US Government Printing Office.