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Spending In The Tax Law Exceeds Discretionary Spending!

Spending In The Tax Law Exceeds Discretionary Spending!

On February 11, 2021, the Congressional Budget Office (CBO) released: The Budget and Economic Outlook: 2021 to 2031. It is grim as CBO estimates that the federal budget deficit for FY 2021 will be $2.3 trillion. But, that is $900 billion less than for 2020. The 2021 deficit is the second largest since 1945 (WWII) based on the deficit as a percent of GDP.

Something else interesting in the report is an appendix on tax expenditures. Tax expenditures are spending that exists in the tax law. For example, the American Opportunity Tax Credit provides taxpayers with a $2,500 tax credit for each of the first four years of college. While this government spending could have instead been given by a direct grant payable to the university to cover the students tuition, it was put into the tax law as a tax reduction. Whether as a tax credit or a direct grant, the financial effect to the government budget and the student are the same. Per CBO, there are over 200 tax expenditures (special rules) in the Federal income and employment taxes.

But, as a tax expenditure, the spending exists until Congress repeals it where as the Department of Education has to ask annually for funding for Pell Grants which are direct spending to help college students. As a tax expenditure, the spending is often overlooked as most people think government spending only exists in the budgets of government agencies.

For the past few years, discretionary spending and spending buried in the tax law have each been about $1.3 trillion. Now the CBO reports that for FY2021, tax expenditures represent $1.8 trillion of spending (8.2% of GDP) and “exceeds all projected discretionary outlays combined.” [see pages 19-20 of the CBO report]

We tend to ask questions about discretionary spending such as why is $x spent on low-income housing or $x spent on something else but not ask why $25 billion is spent on subsidizing the mortgage interest costs of less than 10% of individuals who itemize and claim a mortgage interest deduction on their return (and 63% of this benefit goes to those with income of $200,000 of more [see JCT report, page 42]).

A few observations:

  • Transparency and accountability to taxpayers are violated when we bury spending in the tax law.
  • Most of these tax expenditures are exclusions and deductions which are designed to provide a greater benefit to taxpayers in higher tax brackets. How do they affect the progressivity of the tax system?
  • Special rules lead to violation of the neutrality and simplicity principles.
  • Tax rates could be lower without the special rules.
  • How about adding a new form that lists the most common tax expenditures such as mortgage interest deduction and exclusion for employer-provided health insurance to help individuals see their tax savings from the special rules they use. That will also help them see the equivalent of “direct government spending” they are the beneficiary of.
What do you think? Should we pay more attention to tax expenditures? How? Annette Nellen

Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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One thought on “Spending In The Tax Law Exceeds Discretionary Spending!

  1. Avatar Brett M Layton says:

    Great article. I wonder how they score mortgage interest? With a $750K, low interest rates, and increased standard deduction, it seems to me they have pushed a lot of interest deduction out of tax benefit range… What do you think. I am not an expert on revenue scoring, but my cynical nature views it as having been gamed by the players.

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