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Is the Tax Expenditure Concept Still Relevant?

Leonard E. Burman

Published: September 02, 2003
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Forthcoming in National Tax Journal, September 2003. Reproduced by permission of National Tax Association.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).


Introduction

The term "tax expenditure" is attributed to Stanley S. Surrey who, as Assistant Secretary of the US Treasury for Tax Policy, instructed his staff to compile a list of preferences and concessions in the income tax that had the nature of expenditure programs. His goal was straightforward: to draw attention to these items in hopes of building momentum for tax reform, which would redirect the tax system toward its core function of raising revenues.

Stanley Surrey and coauthor, Paul R. McDaniel, defined the concept thus in their 1985 treatise on the subject:

The tax expenditure concept posits that an income tax is composed of two distinct elements. The first element consists of structural provisions necessary to implement a normal income tax, such as the definition of net income, the specification of accounting rules, the determination of the entities subject to tax, the determination of the rate schedule and exemption levels, and the application of the tax to international transactions. The second element consists of the special preferences found in every income tax. These provisions, often called tax incentives or tax subsidies, are departures from the normal tax structure and are designed to favor a particular industry, activity, or class or persons. They take many forms, such as permanent exclusions from income, deductions, deferrals of tax liabilities, credits against tax, or special rates. Whatever their form, these departures from the normative tax structure represent government spending for favored activities or groups, effected through the tax system rather than through direct grants, loans, or other forms of government assistance. (p. 3)

Seven years after Treasury first published a list of tax expenditures in 1967, the Congressional Budget Act of 1974 required the Administration to publish a list of tax expenditures as part of its annual budget submission. The concept also gained widespread acceptance outside of the United States. Both Canada and the United Kingdom started publishing lists of tax expenditures in the late 1970s, and many other OECD countries had either adopted formal tax expenditure budgets or conducted preliminary studies by 1985. (Surrey and McDaniel, 1985)

The Budget includes tax expenditures, defined as deviations from the "normal" individual and corporate income tax bases, along with its estimates of direct expenditures. Until 2002, it also included a list of tax expenditures against a transfer tax (estate and gift taxes) baseline, but those items were excluded from the FY 2003 budget because " ...there is no generally accepted normal baseline for transfer taxes and ... [the tax was]... repealed under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)."1 (US Office of Management and Budget, 2002, p. 95) In principal, tax expenditures could also be defined with respect to other taxes, such as excise taxes, but it has not been done on a systematic basis. (Davies, 1994)

Most budget experts view the tax expenditure budget as a useful tool in managing the size and scope of the federal budget, but a growing contingent of conservative critics has raised questions about the concept. That critique was elevated to new heights in 2002 when President Bush's budget introduced the tax expenditure section with a warning that " ...the Administration believes the meaningfulness of tax expenditure estimates is uncertain..." and promised a new more meaningful presentation in future years. (US Office of Management and Budget, 2002, p. 95)

The paper discusses the measurement of tax expenditures as implemented in the United States, the debate about the relevance of the tax expenditure concept as highlighted by the Bush Administration, and the way tax expenditure estimates are used in the United States.

Note: This report is available in its entirety in the Portable Document Format (PDF).


Note that repeal is not effective until 2010, and only for one year. Also, the Administration produces tax expenditure estimates for other expiring provisions, such as work opportunity tax credits, so the repeal argument for excluding the estate tax is a bit disingenuous. The more likely reason is that the Administration does not believe that the estate tax should exist. The Joint Committee on Taxation has never published estate tax expenditures.