Jane G. Gravelle Senior Specialist in Economic Policy
Thomas L. Hungerford Specialist in Public Finance
interest in a major reform of the individual income tax that would broaden the
base and use the additional tax revenues to lower rates and/or reduce the
deficit has increased. The President’s Fiscal Commission, for example,
proposed an individual income tax reform with three objectives: to broaden
the base and lower the tax rate, to contribute to deficit reduction, and to maintain
or increase the progressivity of the tax system. The Fiscal Commission proposed
to broaden the tax base by eliminating or modifying most tax expenditures.
One legislative proposal in the 112th Congress,
S. 727, introduced by Senators Wyden, Begich, and Coats, would broaden the
tax base by eliminating many tax expenditures and reduce tax rates.
One way to broaden the tax base is to eliminate or reduce tax expenditures,
which have been in the tax code since the passage of the progressive
income tax in 1913. An understanding of four complex issues surrounding
tax expenditures is necessary for an informed debate over broadening the
tax base. First, tax expenditures affect the economic behavior of taxpayers
(efficiency effects). Second, changing tax expenditures will change the
distribution of tax benefits, and the distribution of after-tax income
(equity effects). Third, changes to tax expenditures could change the
administrative burdens on taxpayers and the Internal Revenue Service (IRS).
Lastly, many tax expenditures are popular among taxpayers and voters. Each
one of these issues presents challenges to broadening the tax base, which
could be difficult to overcome.
There are over 200 separate tax expenditures, which are projected to total over
$1.1 trillion in FY2014. The revenue loss of all tax expenditures,
however, is highly concentrated in a relatively small number—the largest
20 tax expenditures account for 90% of the total revenue loss of all tax expenditures.
This amount is equivalent to 74% of the total FY2014 revenue from individual income
taxes. If used for rate reduction alone, eliminating these tax expenditures
could allow tax rates to be reduced by around 43%: for example, the top
39.6% tax rate could be reduced to approximately 23%.
When evaluating tax expenditures as potential base broadening provisions, it is
useful to consider the general kinds of behaviors they affect or the
general objectives in determining the feasibility of eliminating or
modifying specific tax expenditures. Consequently, tax expenditures are divided into
seven major categories: saving, business investment, consumption,
owner-occupied housing (which is a combination of an investment choice and
a consumption choice), labor supply, government programs (which in many
cases would have no behavioral effects but are simply income transfers),
and a category termed structural (which provides benefits based on family circumstances
rather than affecting behavior).
The analysis in this report suggests there are impediments to base broadening
by eliminating or reducing tax expenditures, because they are viewed as
serving an important purpose, are important for distributional reasons,
are technically difficult to change, or are broadly used by the public and
quite popular. Given the barriers to eliminating or reducing most tax
expenditures, it may prove difficult to gain more than $100 billion to $150
billion in additional tax revenues through base broadening. This amount
could have a significant effect on reducing the FY2014 budget deficit—reducing
the projected $345 billion deficit by 30% to 43%. This additional tax revenue,
however, is equivalent to about 6% to 9% of projected FY2014 individual income
tax revenue, and, consequently, would not allow for significant reductions
in tax rates (about a one or two percentage point reduction for each
Date of Report: January 11, 2013
Number of Pages: 41 Order Number: R42435 Price: $29.95
For email and phone orders, provide a Visa, MasterCard, American Express, or Discover card
number, expiration date, and name on the card. Indicate whether you want e-mail
or postal delivery. Phone orders are preferred and receive priority processing.