Tax Expenditures: Who Benefits from Hidden Subsidies?

I’m excited about Pew Charitable Trust’s new website, Subsidyscope. It presents a first-of-its-kind database of federal tax expenditure estimates from the Department of Treasury (Treasury) and the Joint Committee on Taxation (JCT).  That’s really good news, but there’s a really big subsidy for the rich that’s missing from the database: tax rates on capital gains and dividends.

The term “tax expenditure” refers to revenue lost through special or preferential provisions in the Internal Revenue Code.  Unlike direct spending – where Congress appropriates money to be spent for a specific purpose – tax expenditures are created outside the normal budget process.  They don’t receive the same annual scrutiny as direct spending.  There’s no system in place for changing or eliminating programs that become outdated, redundant, inefficient, or simply unaffordable.  The tax code now has around 250 tax expenditures, double the number from only a few years ago, resulting in more than $1 trillion in forgone revenue a year (more than 6 percent of GDP).

The subsidy for capital gains and dividends takes the form of lower tax rates on profits from assets such as stocks, bonds, investment or vacation real estate, art or antiques than on the salaries and wages earned by most of us.  Treasury, JCT, and the Tax Policy Center (TPC) all consider it in their analyses of tax expenditures.  According to TPC, the subsidy costs about $99 billion in lost revenue (not including the effect of the Alternative Minimum Tax) and provides little benefit to anyone other than the wealthiest one percent of taxpayers.

As commentator Ezra Klein recently pointed out, tax expenditures are spending that’s hidden in the tax code. Klein focuses on what he calls “welfare for the middle class”—including the tax deduction for interest on mortgages up to $1 million and the tax exclusion for employer-provided health care insurance premiums. Although Klein’s post does not mention the tax code’s subsidy for unearned income (lower rates for capital gains and dividends than for ordinary income), the subsidy is a perfect example of the role of tax expenditures as welfare for the wealthy.

Transferring funds through tax breaks is usually more politically appealing than direct spending, but it tends to favor higher-income people because exclusions and deductions from income are more valuable to taxpayers in higher tax brackets; low-income taxpayers with limited federal income tax liability can’t take advantage of many tax preferences.  And very few low- and moderate-income taxpayers receive income from capital gains.  Tax loopholes that favor wealthy individuals and powerful corporations undercut the fairness, efficiency, and transparency of the tax system.

In light of their high cost and regressive nature, tax expenditures should be at the top of Congress’s reform agenda.  This country can’t address the long-term federal deficit without reforming the spending that’s hidden in the tax code.  The workers of America shouldn’t have to continue subsidizing the wealthiest one percent.