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Saturday, April 30, 2011

"Richest" tax expenditures

A article of April 26, 2011 by Jeanne Sahadi, has the title "America's Richest Tax Breaks." This caught my attention in that I was thinking it would be about tax deductions, exclusions and credits (and lower capital gains tax rate) claimed by high income individuals. But the article is about the most "expensive" tax expenditures, which the articles states are:

  • Health care and insurance at $132 billion/year (not counting payroll taxes; this figure represents the income tax "cost")

  • Retirement savings at $103 billion/year

  • Mortgage interest at $97 billion/year

  • Capital gains/dividends (15% or lower rate) at $81 billion/year

  • Earned Income Tax Credit at $54 billion/year

The article notes that the above five represent 42% of all tax expenditures out of the $1.1 trillion we have heard mentioned by President Obama's Deficit Commission and others. As I have noted before, the bulk of the $1.1 trillion is attributable to the individual income tax, not the corporate income tax (see 2/11/11 post and article linked there).

The CNNMoney article does a good job of describing these expenditures in terms of why they exist, who benefits and suggestions for reform. The article also notes that there will be need for bipartisan work to reduce or eliminate many of these tax expenditures for tax reform purposes. Per the author:

"if lawmakers are serious about overhauling the code in a way that substantially reduces rates, they'll have to address the biggest and most beloved tax breaks."

So, back to the word "richest" - appropriate? The 5 tax expenditures focused on in the article are a mix of types:

  • exclusion

  • deduction

  • special rate structure

  • refundable credit

Other than the EITC, these special rules provide the highest benefit to individuals in a high tax bracket. For example, a $10,000 mortgage interest deduction represents a tax savings of $3,500 for someone in the 35% tax rate, but only $2,000 to someone in a 20% bracket. The lower rate for capital gains and qualified dividends also mostly benefits high income individuals who would otherwise have a 20% or 35% rate respectively, for these items. The benefit is mostly to this group because they have more capital gains and dividends than other individuals. So, "richest" should have really been "largest."

I think it is good to see the topic of "tax expenditures" getting attention in the popular press rather than only in documents that tax practitioners and economists read. If the majority of voters realize that they don't use many of these tax expenditures, but help pay for them by not getting some tax benefit (such as a lower rate or larger standard deduction) that could benefit more people if the special rule were not in place, I think more people would be speaking for reform.

And, fewer tax expenditures also means the tax law is simpler and more neutral (not affecting decision-making).

What do you think?

1 comment:

Anonymous said...

I did not read the CNN article, although I will, but I agree that most Americans do not fully understand the impact of how tax deductions, exclusions, and credits affect the Federal budget. I'm glad it's getting some attention.