Tax Expenditures: Good or Bad? Benefit or Burden?

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Richard F. Keevey
July 5, 2024

The Tax Policy Center describes tax expenditures as: “forgone revenues from special provisions in the tax code such as exclusions, deductions, deferrals, credits and preferred tax rates that benefit specific activities or groups of taxpayers.”

Tax expenditures enable targeted groups to reduce their taxes relative to the ‘basic’ tax structure.’ Tax Expenditures are adopted to encourage certain types of behavior or provide financial assistance to certain taxpayers. Many tax expenditures do advance important policy goals, such as: attract business or spur economic behavior; assist nonprofits; support ‘deserving’ groups of individuals, such as seniors and veterans and low-income families and in the case of state governments, correct inequalities in a tax system by exempting, for example, certain products from a sales tax. Many experts refer to tax expenditures as “ spending via the tax code.”

Tax Expenditures alter the distribution of the tax burden or create incentives for taxpayers to change economic behavior. Tax expenditures are less transparent than appropriations and are usually not subject to the same detailed review that is associated with ongoing budgetary appropriations. But, they may provide economic benefits or offer an alternative to direct governmental appropriations.

Unfortunately, because of the absence of annual and critical evaluation these ‘tax breaks usually remain in the tax code unchecked for many budget cycles. Not a good situation.

Tax expenditures exit in the federal and state tax codes (and vary by state).

Impact of Tax Expenditures

Tax expenditures reduce the amount of revenues that a government would normally receive. For example, in the federal tax code the value of “forfeited” revenue is $1.8 trillion. That is more than total spending in the federal budget for Medicare and Defense.

Each state has a list of tax expenditures. The total of tax expenditures in all states is estimated at $1 trillion but vary by state. For example, New Jersey has an estimated $25 billion in tax expenditures  (budgeted state-own revenue is $55 billion).

A key point: Tax expenditures are not loopholes or earmarks that are slipped into the law to benefit a handful of well-connected people. A loophole allows the tax law to be circumvented; an earmark is a directed spending item for a specific project.

In contrast, tax expenditures are specifically crafted in statute to allow special exclusion, exemption or credit that usually benefits tens of millions of taxpayers.

Tax expenditures principally benefit higher-income people and corporations. In the federal tax code, for example 70 percent of all tax expenditures benefit the top 5% of taxpayers. Similar situations exist in the states.

Some Observations

Are tax expenditures good policy? Well, maybe. If we eliminated all tax expenditures we could easily balance the annual federal budget. State governments would have additional revenues to spend on needed programs, or the income-tax or sales-tax rates could be reduced. But, many people would complain if their particular benefit was reduced or eliminated. They might argue for eliminating benefits to corporations, but not their tax benefits. Corporations would have similar views, arguing that eliminating their tax expenditure would impact their bottom line, limit capital investments and limit competitiveness.

In general, tax expenditures harm the efficiency and effectiveness of the tax system. Economic literature identifies four key shortcomings of tax expenditures: the tax base is narrowed; inequities are created across taxpayers; benefits disproportionally accrue to high-income folks; and they are much less transparent than direct spending.

More important, tax expenditures are expensive and recur each year. The Pew Charitable Trust suggests most states do not routinely review these preferences because they are not part of the regular annual  budget process. With no one watching it is easy to lose track of who gets these preferences and what the public receives in return.

The Volcker Alliance recommends five elements to improve evaluation and disclosure of tax expenditures:

• Clearly delineate the policy and political reasons and consider the cost and effectiveness of policy alternatives such as direct spending;
• Create key performance indicators to evaluate whether tax policies are satisfying original objectives;
• Establish sunsetting provisions and periodically access the value of each tax expenditure;
• Produce a ‘budget’ that reports direct tax expenditure estimates by budge category;
• Deploy professional staff to analyze and track tax expenditures 

Furthermore, the following question is appropriate: Who exactly is benefiting and is the benefit to groups really in need of assistance? As an overall guide one should consider these criteria for each tax expenditure:

• What are its goals and objectives?
• What are the major economic effects—both intended and unintended?
• How much revenue is reduced?
• What are the administrative costs?
• What groups are most affected?
• Do the benefits justify the lost revenue?

And, most important: Are there alternative policies that could achieve the same results more effectively or efficiently, such as straight-forward and visible appropriations?

No matter how outdated or arcane, each tax expenditure has a constituent. Many of the preferences involve children, veterans, seniors and corporations. Thus, policy change is difficult but in my view certainly no more challenging than direct budgetary spending.

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Author: Richard Keevey is the former Budget Director for New Jersey, where he was appointed by two governors from each political party. He was also appointed by President Clinton as the Assistant Secretary and Chief Financial Officer at HUD (with Senate confirmation) and Deputy Undersecretary of Defense for Finance. He is presently a Senior Policy Fellow at Rutgers University.

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