Tax Expenditures and Complexity

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I returned last week from a conference that focused on the challenges that tax agencies across the world face in administering tax systems. One part of our tax system stood out in comparison with other systems. While most systems rely in some part on tax agencies to administer tax laws that promote social goals in addition to raising revenue, IRS seems to be the champ in terms of administering social programs embedded in the tax laws.

The other day the Congressional Budget Office released a blog post summarizing tax expenditures. Whether a particular item in the Code is classified as an expenditure is subject to some debate, but the CBO defines the terms as an “array of exclusions, deductions, preferential rates, and credits that reduce revenues for any given level of tax rates in the individual, payroll, and corporate income tax systems.”

Like direct spending, tax expenditures promote certain activities (like home ownership) or benefit some classes of taxpayers or entities. CBO estimates that tax expenditures will reach around $1.5 trillion in 2017, or around half of all federal revenues.

As the CBO blog post notes, the top expenditures in terms of total revenues foregone are the following:

  1. The exclusion from workers’ taxable income of employers’ contributions for health care, health insurance premiums, and premiums for long-term care insurance;
  2. The exclusion of contributions to and the earnings of pension funds (minus pension benefits that are included in taxable income);
  3. Preferential tax rates on dividends and long-term capital gains;
  4. The deferral for profits earned abroad, which certain corporations may exclude from their taxable income until those profits are returned to the United States; and
  5. The deductions for state and local taxes (on nonbusiness income, sales, real estate, and personal property).

The CBO post and its link to recent Congressional testimony and an annual Joint Committee report discussing tax expenditures have more detail on these and others (like refundable credits, deductions for charitable contributions and home mortgage interest deductions).

The National Taxpayer Advocate, in her 2016 annual report has noted the complexity and burden that follows from many expenditures. Congress’ desire to target benefits to certain taxpayers or reward certain activities often is accompanied by complexity in terms of eligibility criteria. Not surprisingly, lobbyists can influence legislation in ways that are meant to hide the impact of provisions that favor certain industries or even specific taxpayers.

As Congress perhaps turns its attention to tax reform (though there seems to be many legislative balls in the air so reform is no sure thing), it would be wise for Congress to consider administrability and complexity in determining whether the IRS is the appropriate agency to be in charge of specific programs or benefits.

In this year’s annual report the NTA proposes that Congress take a “zero-based budgeting” approach that specificically calls on Congress to weigh burdens on taxpayers and the IRS:

The starting point for discussion would be a tax code without any exclusions or reductions in income or tax. A tax break or IRS-administered social program would be added back only if lawmakers decide, on balance, that the public policy benefits of running the provision or program through the tax code outweigh the tax complexity burden the provision creates for taxpayers and the IRS.  At the end of the exercise, tax rates can be set at whatever level is required to raise the amount of revenue that Congress determines is appropriate.

There are many specific targets for consideration if Congress is not up for the task of taking on wholesale reform. When one considers the array of education benefits and the hodgepodge of family status benefits embedded in the tax code it seems like a Congress intent on simplifying the lives of taxpayers and IRS would have plenty of places to start.

 

 

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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