Tax loopholes, credits and deductions disproportionately favor the richest Americans, according to a new study by the Congressional Budget Office.
The CBO report argues that for the 10 largest tax expenditures in the individual income tax system — employer-sponsored health insurance, net pension contributions and earnings, capital gains on death-transferred assets, Social Security and Railroad Retirement benefits, state and local taxes, mortgage interest payments, charitable contributions, preferential tax rates on capital gains and dividends, the earned income credit and the child tax credit — the richest 20 percent of American households receive more than 50 percent of the benefits. For fiscal year 2013, the tax provisions are estimated to cost the government more than $900 billion, or 5.7 percent of the nation’s gross domestic product.
The wealthiest 1 percent of American households get 17 percent of the tax benefits, while the bottom one-fifth of the population receive only 8 percent. For the poorest 20 percent, these benefits constitute 12 percent of their after-tax income, while they make up only 9 percent of the after-tax income of the wealthiest quintile.
“The CBO report underscores the need to go beyond the rhetoric of lowering tax rates without indication of how that would be achieved or the implications for economic growth and tax equity,” said Rep. Sander Levin (D-Mich.), the top Democrat on the tax-writing Ways & Means Committee. “The preferences that benefit the very wealthy highlight the ability to obtain the needed revenues to address the sequester and achieve a balanced approach to tax reform.”
Rep. Paul Ryan (R-Wis.), chair of the House Budget committee, told CNBC Wednesday that Washington is “picking winners and losers based upon loopholes, based upon who you know. We want to get out of that business, get our tax rates down, so it’s fair across the board.” Ryan’s spokesperson, William Allison, echoed the representative’s sentiment.
“CBO’s report makes it clear: Our tax code is broken. It’s complex and unfair. It stifles job creation,” Allison said. “The House-passed budget calls for a simpler code that lowers rates for all Americans.”
Most analysts see the Ryan budget as unworkable and heavily preferential to the wealthy.
The controversy about tax expenditures
For the most part, the wealthy benefit most from tax expenditures because they are generally proportionate to individual income. As the CBO report points out, more than 90 percent of the benefits of reduced tax rates on capital gains and dividends goes to the top one-fifth, while almost 70 percent goes to the top 1 percent. On the other hand, half of the benefits of the earned income credit go to the lowest 20 percent of earners, constituting 6 percent of the after-tax household income for that group.
In all, most expenditures favor the very rich or the very poor. The middle three quintiles receive less than 8 percent in after-tax income benefits from tax expenditures.
There are those, however, that believe that the congressional think tank’s analysis is warped. The Tax Foundation is one of the report’s critics, based on an admission the report makes.
“Tax expenditures are measured relative to a comprehensive income tax system,” the CBO report states.
“If tax expenditures were evaluated relative to an alternative tax system — for instance, a comprehensive consumption tax, such as a national retail sales tax or a value-added tax — some of the 10 major tax expenditures analyzed here would not be considered tax expenditures. For example, because a consumption tax would exclude all savings and investment income from taxation, the exclusion of net pension contributions and earnings would be considered part of the normal tax system and not a tax expenditure.”
The Tax Foundation argues if we were to admit that the American tax system was flawed, then — in an ideal system — consumption taxes would be better for economic growth than income taxes. The costliest exemptions, such as employer-sponsored health insurance, the earned income tax credit and the child tax credit constitute a more troublesome expenditure than investment-rewarding expenditures like those on capital gains, charitable deductions and mortgage-interest payments, according to the Tax Foundation.
Kevin Drum of Mother Jones argues that the claims of favoritism to the wealthy the CBO report asserts is only partly correct. Drum questions whether mortgage interest, charitable contributions and state and local taxes can fairly be said to favor the wealthy, noting that the effect of the standard deduction is not counted even though it provides similar tax benefits to low-income individuals.
Finally, a contrasting report issued by the Government Accountability Office claims the Internal Revenue Service does not have enough data available to identify the beneficiary for nearly half the value of U.S. tax expenditures. This information is unavailable because many exemptions do not have their own line on a tax form or are part of larger calculations. These exemptions — such as the $102 billion of tax exemptions excluded from tax forms, such as life insurance savings, and the $390 billion “shared-calculations” exemptions, such as clean renewable energy bonds — make it nearly impossible for the IRS to properly account for how tax credits are being expended.
By law, the IRS can only collect data required by the tax code. As details about these expenditures are not explicitly requested by law, the IRS has no right to inquire about them.
Income inequality
Ultimately, the CBO report illustrates that the current system of tax expenditures is aggravating, instead of mitigating, the income inequality currently seen in America. Tax expenditures, simply put, are spending programs encoded into the tax code that automatically redistribute tax revenues for a specific reason — typically, the lowering of tax liability, special credit or the introduction of a preferred tax rate. These include end-of-year tax credits and deductions, pre-tax income deductions and tax refunds or rebates.
Because the majority of these expenditures are only available through tax itemization — which only benefits higher-income bracket earners — and are proportionate to the actual income paid, these expenditures create a system of unequal treatment. As reported by American Progress, because tax expenditures are not subject to the congressional appropriation process, they have doubled from 1974 to 2004, with many masquerading as tax cuts.
Currently, tax expenditures, at $942 billion as of fiscal year 2012, are the federal government’s single largest expenditure — more than the $553 billion spent on defense, $829 billion spent on Social Security or $872 billion spent on Medicare and Medicaid.
Currently, more than half of all energy projects in the United States are funded by tax expenditures. According to Credit Suisse, the largest single tax expenditure for 2012 is the exclusion for employer-sponsored health insurance at $171 billion, followed by exclusion of pension contributions and earnings at $138 billion, mortgage interest deduction at $87 billion, machinery and equipment accelerated depreciation at $76 billion and deferred income from foreign corporations at $42 billion. The child credit came in 14th at $24 billion. At a 2010 cost of between $8 billion and $10 billion, the earned income tax credit did not make the list of the top 20 tax expenditures.
James Kwak for the Baseline Scenario argued the realities of tax expenditures best:
“You can have a debate about what is or is not a tax expenditure. You can even have a debate about whether the whole concept makes sense, since the identification of something as a tax expenditure presumes some baseline in which that particular loophole doesn’t appear. But the latter debate is, in my opinion, philosophical at best. It’s pretty clear that the tax code includes some basic principles (like taxing income) and some exceptions (like not taxing a portion of your income equivalent to the amount of mortgage you pay on your house and your vacation house); the latter are tax expenditures.”