Tax expenditures are revenue losses attributable to tax provisions that often result from the use of the tax system to promote social goals without incurring direct expenditures. How tax expenditures are structured affects both who will benefit from them and how much they will reduce federal revenues.
- Income tax provisions generally seek to promote one or more of three broad objectives: measuring income accurately, distributing fiscal benefits and burdens based on a household’s ability to pay, and promoting activities or behavior that are considered socially desirable. Tax expenditures are tax provisions that are not structural features of the income tax or necessary to measure income accurately.
- There is some debate about whether distributionally-oriented tax provisions should be considered tax expenditures and, if so, which ones should be. Similarly, commentators debate which provisions should be considered structural features of the income tax.
- Each year the Office of Tax Analysis at the Treasury Department and the Joint Committee on Taxation publish separate lists of income tax expenditures and their estimated cost in foregone revenue. Some commentators have suggested that this Tax Expenditure Budget should be broadened to include tax
expenditures within the payroll, wealth transfer, and excise taxes.
- Tax expenditures can take many forms. Some result from tax provisions that reduce the present value of taxable income through deferral allowances, or special exclusions, exemptions, or deductions from gross income. Others affect a household’s after-tax income more directly through tax credits or preferential rates for specific activities.
- Individual income tax expenditures are typically structured either as deductions or exclusions, non-refundable tax credits, or refundable tax credits. With non-refundable credits, taxpayers may only use the credit to reduce or eliminate positive income tax liability. In contrast, refundable credits do not have that restriction: if the credit exceeds pre-credit tax liability, the tax filer still receives the excess as a payment.
- Deductions and exclusions accounted for more than 80 percent of the major individual income tax expenditures in 2008 (see figure 1). However, the use of refundable tax credits has increased over time, primarily because of the growth of the earned income tax credit (EITC) (see figure 2).
tax credits what are they