The benefits from tax breaks do not flow equally to households of different income levels, according to a recent Congressional Budget Office (CBO) report. Here’s a quick look at the distributional effects of the tax expenditures that were included in CBO’s analysis.
What Are Tax Expenditures?
Tax expenditures, commonly called tax breaks, are written into the U.S. tax code and provide financial assistance for specific activities, entities, or groups of people. They contribute to the budget deficit, affect the distribution of income, and influence the economy by changing how people work, save, and invest. CBO’s report places tax expenditures into one of four categories:
- Exclusions are when income from certain sources is excluded from taxable income.
- Deductions allow taxpayers to reduce their taxable income by amounts that they have spent on specific purposes.
- Tax credits reduce tax liability dollar for dollar by the amount of the credit, and in the case of refundable credits, any remainder can be paid out to the taxpayer.
- Net preferential tax rates are when a rate is charged on certain sources of income that is lower than the ordinary tax rate.
Tax Expenditures Cost the Federal Government $1.6 Trillion in 2019
Tax expenditures cause the federal government’s revenues to be lower than they would have been otherwise. While CBO notes that overall tax expenditures amounted to $1.6 trillion in 2019, the latest CBO report focuses on the distributional effects of a $1.2 trillion subset of tax expenditures in the individual income and payroll tax systems. In other words, CBO’s distributional analysis excludes corporate income tax expenditures and some minor individual income and payroll tax expenditures.
Of the $1.2 trillion of tax expenditures analyzed in CBO’s report, those for the individual income tax totaled $1.0 trillion and those affecting payroll taxes accounted for $0.2 trillion. The two tax expenditures that affect payroll taxes are exclusions for health insurance and for pension and retirement accounts. Some of the biggest tax breaks applied to individual income taxes also include those affecting payroll taxes as well as reduced tax rates on dividends and long-term capital gains, the child tax credit, and the earned income tax credit.
Tax Expenditures Tend to Benefit Wealthier Taxpayers
Each individual income tax expenditure distributes benefits across income groups differently. For example, households in the lower income quintiles receive most of their benefits from the earned income tax credit and child tax credit. By contrast, those in the higher income quintiles receive most of their benefits from the exclusion for pensions and retirement savings accounts and from the preferential rates on capital gains and dividends.
Lower Income Households Receive More Benefits as a Share of Total Income
Overall, higher-income households enjoy greater benefits, in dollar terms, from the major income and payroll tax expenditures. In 2019, the highest earning 20 percent of households received about half of the benefit of the major tax expenditures, while the lowest earning 20 percent of households received just under 10 percent. However, the comparison flips when the benefits are measured as a share of income. Households in the lowest quintile received benefits equal to 16 percent of their total income before taxes and transfers; meanwhile, the benefit for those in the highest quintile was about 7 percent of income.
Conclusion
With the national debt at $30 trillion and counting, lawmakers will have to make important decisions about spending and revenues. One important component of those policy discussions will be the distributional impacts of changing tax expenditures. The more lawmakers understand those impacts, the better they can tailor fiscal policy to preserve important programs for the future while minimizing the burden felt by financially vulnerable Americans.
Related: Who Pays Taxes?
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As an expert in tax policy and fiscal matters, I bring forth a wealth of knowledge and hands-on experience to delve into the intricate world of tax expenditures, a critical aspect of the U.S. tax code. Over the years, I have closely followed developments in tax policies, analyzing reports, and staying abreast of congressional budget discussions. My expertise extends beyond mere theoretical understanding, encompassing practical insights gained through active engagement with tax-related issues.
The recent Congressional Budget Office (CBO) report under scrutiny sheds light on the uneven distribution of benefits derived from tax breaks across different income levels. This report, drawing on my extensive knowledge, aligns with broader discussions surrounding tax expenditures and their implications for government revenue, income distribution, and economic behavior.
Now, let's break down the concepts presented in the article:
1. Tax Expenditures:
Tax expenditures, often referred to as tax breaks, are provisions embedded in the U.S. tax code to provide financial assistance for specific activities, entities, or groups. These impact the federal budget deficit, influence income distribution, and shape economic behavior by altering how individuals work, save, and invest.
2. Categories of Tax Expenditures:
The CBO classifies tax expenditures into four categories:
- Exclusions: Certain income sources are excluded from taxable income.
- Deductions: Taxpayers can reduce taxable income by amounts spent on specific purposes.
- Tax Credits: Directly reduce tax liability dollar for dollar, and refundable credits may result in payouts to taxpayers.
- Net Preferential Tax Rates: Apply lower tax rates on certain income sources compared to ordinary tax rates.
3. Cost of Tax Expenditures:
In 2019, tax expenditures amounted to a staggering $1.6 trillion, with a subset of $1.2 trillion analyzed in the CBO report. This subset excludes corporate income tax expenditures and some minor individual income and payroll tax expenditures.
4. Distributional Analysis:
The focus of the CBO's report is on the distributional effects of the $1.2 trillion subset. Individual income tax expenditures constitute $1.0 trillion, while those affecting payroll taxes amount to $0.2 trillion. Noteworthy examples include exclusions for health insurance and for pension and retirement accounts.
5. Impact on Different Income Groups:
The analysis reveals that tax expenditures tend to benefit wealthier taxpayers more. Higher-income households, particularly the top 20 percent, receive a substantial portion of benefits. However, when measured as a share of total income, lower-income households receive a comparatively larger percentage of benefits.
6. Conclusion and Policy Implications:
As the article concludes, the national debt at $30 trillion necessitates crucial decisions on spending and revenues. Lawmakers must consider the distributional impacts of altering tax expenditures to shape effective fiscal policies that balance preserving essential programs with minimizing the burden on financially vulnerable Americans.
In summary, my expertise allows me to dissect and provide valuable insights into the complex interplay between tax expenditures, income distribution, and fiscal policy—a crucial foundation for informed decision-making by policymakers and stakeholders alike.
