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The Congressional Budget Office (CBO) is required by Section 308(c) of the Congressional Budget Act of 1974 to issue a report annually that projects tax expenditures for each of the next five fiscal years. This report fulfills that statutory requirement for fiscal years 1984 to 1988.
The report also reviews the difficulties in defining and measuring tax expenditures. Different interpretations of these issues may produce different tax expenditure lists. The report compares the revenue loss and outlay equivalent approaches to estimating tax expenditures and outlines the differences between the recent Congressional and Administration tax expenditure lists. Finally, the report surveys the use of tax expenditure lists in other countries to show how other governments have applied this concept. These comparisons help to demonstrate the difficulties involved in defining and measuring tax expenditures and to illustrate the usefulness of information on tax expenditures.
The report was prepared by Martha J. Smith and Robert Lucke of CBO's
Tax Analysis Division, under the supervision of James M. Verdier and Rosemary
Marcuss. A number of persons inside and outside CBO provided valuable comments,
including Peter Davis, Larry Dildine, Robert L. Faherty, Seymour Fiekowsky,
Alfred B. Fitt, Harvey Galper, Robert N. Hartman, Paul R. McDaniel, Michael
McKee, Joseph Minarik, Kathleen O'Connell, Joseph A. Pechman, Frederick
C. Ribe, Stanley S. Surrey, Stephan Thurman, Paul Van de Water, and James
W. Wetzler. In addition, valuable assistance on the international experience
chapter was provided by M.E. Aldons, Bernard Castagnede, J.J.M. Exeter,
Max Frank, Wolfgang Glomb, Victor Halberstadt, Peter Heller, Lotfi Maktouf,
Nils Mattsson, Bonnie Moynihan, J.P. Owens, Jean-Francois Pons, G. Renard,
Juan Rincon, Phillip M. Smith, and T.S. Ward. Patricia H. Johnston edited
the manuscript and Linda Brockman and Shirley Hornbuckle typed it.
Rudolph G. Penner
Director
October 1983
SUMMARY
CHAPTER I. INTRODUCTION
CHAPTER II. DIFFERENCES BETWEEN TAX EXPENDITURE LISTS
CHAPTER III. EXPERIENCE WITH TAX EXPENDITURE BUDGETING IN OTHER COUNTRIES
APPENDIX A. TAX EXPENDITURE ESTIMATES FOR FISCAL YEARS 1983-1988
APPENDIX B. TAX EXPENDITURES WITH EXPIRATION DATES
APPENDIX C. DIFFERENCES BETWEEN THE ADMINISTRATION AND JCT/CBO TAX EXPENDITURE LISTS
APPENDIX D. DIFFERENCES IN MEASURING REVENUE LOSSES AND OUTLAY EQUIVALENTS
| TABLES | |
| 1. | ESTIMATED REVENUE EFFECTS OF CHANGES IN TAX EXPENDITURES IN THE TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982, FISCAL YEARS 1983-1987 |
| 2. | PROVISIONS INCLUDED IN THE CONGRESSIONAL TAX EXPENDITURE LIST BUT NOT IN THE ADMINISTRATION LIST |
| 3. | COMPARISON OF REVENUE LOSSES AND OUTLAY EQUILVALENTS FOR SELECTED TAX EXPENDITURES |
| 4. | GENERAL GOVERNMENT FINANCIAL BALANCES |
| 5. | FEDERAL REPUBLIC OF GERMANY: REVENUE LOSS FROM TAX RELIEF BY AREA OF ECONOMIC ACTIVITY, 1979 TO 1982 |
| 6. | FRANCE: TAX EXPENDITURES BY TAX SOURCE, POLICY OBJECTIVE, AND TYPE OF BENEFICIARY FOR 1980 AND 1982 |
| 7. | SPAIN: TAX EXPENDITURES DISTRIBUTED BY BUDGET FUNCTION, 1981 AND 1983 |
| A-1. | TAX EXPENDITURE ESTIMATES BY FUNCTION AND SUBFUNCTION, FISCAL YEARS 1983-1988 |
| B-1. | TAX EXPENDITURES WITH EXPIRATION DATES |
| D-1. | CALCULATION OF OUTLAY (LOAN) EQUIVALENT FOR AN ASSET IN THE FIVE-YEAR RECOVERY CLASS |
Since the tax expenditure concept was first developed
in the 1960s, the United States and several other countries have found
that it can be a useful tool for government budgeting and policy analysis.
When all the tax expenditure provisions are shown in one place, policymakers
can make decisions with a better understanding of the total allocation
of government resources among policy objectives, economic sectors, and
categories of beneficiaries. By providing information on the amount of
government subsidy delivered through the tax system, tax expenditure lists
correspond to the listings of outlay programs in federal budgets. Review
of both direct subsidies and tax expenditures may be especially useful
when a government is seeking to reduce large federal deficits.
DEFINITION
Tax expenditures are provisions in the tax code that provide incentives for particular kinds of activities or that give special or selective tax relief to certain groups of taxpayers. The investment tax credit, for example, provides an incentive for firms to invest in business machinery and equipment, while the extra $1,000 personal exemption for those age 65 or over gives tax relief to this particular group of taxpayers. Through these allocations of government fax resources, tax expenditures are comparable to direct spending programs. The most recent list of tax expenditure estimates, compiled by the Joint Committee on Taxation and the Congressional Budget Office (JCT/CBO), contains 105 provisions and is presented in Appendix A.
Certain features of an income tax are considered integral parts of the basic structure of the tax and therefore are not viewed as tax expenditures, which are defined as exceptions to these basic tax rules. The integral features include the general rate schedules and exemption levels, the general rules defining who is subject to tax and what accounting periods should be used, and deductions for the cost of earning income.
Although the tax expenditure concept appears straightforward, a number
of complicated definitional issues surround both the selection and measurement
of tax expenditures. One fundamental problem is choosing a consistent set
of basic tax rules--called "reference" tax rules--as the standard against
which tax expenditures are selected and measured. Although there is general
agreement about the reference tax rules, some tax analysts consider several
provisions to be part of the reference tax structure while others do not.
Until recently, the Congress and the Administration have generally concurred
on which provisions should be considered part of the basic tax structure
and which should be viewed as tax expenditures.
MEASUREMENT
The tax expenditure estimates provided in this report are measured on the basis of their "revenue loss." The revenue loss from each tax expenditure is estimated by comparing the revenue raised under current law with the revenue that would be raised if the provision had never existed, assuming that both taxpayer behavior and all other tax provisions remain the same as they are under current law. This is not an estimate of the amount of revenue that would be gained if the provision were repealed, since repeal of the provision probably would change taxpayer behavior in ways that could significantly reduce the revenue gain. Furthermore, the estimates measure only the isolated effect of each provision. Interactions among different tax expenditures and other tax provisions could make the revenue gain from repealing several tax expenditures together either more or less than their repeal separately. It is, therefore, difficult to measure how much revenue the federal government does not collect because of each tax expenditure provision. The amount of revenue the government collects under existing law can be observed directly; the amount of revenue that would be collected under some different law can never be observed directly and can only be estimated.
While estimates of individual tax expenditures are useful in quantifying
the budgetary effect of each provision, the arithmetic total of all the
tax expenditure estimates has significant limitations. Since the cost of
each tax expenditure is estimated by determining how much additional revenue
would be collected if the provision did not exist, adding together estimates
of several different tax expenditures does not produce a valid estimate
of the cost of the group as a whole. For example, as a result of changing
any one tax expenditure provision, more taxpayers might use the standard
deduction instead of itemizing their deductions. On the other hand, some
taxpayers' taxable income might increase and therefore be taxed at higher
marginal rates. When more than one tax expenditure provision is changed,
the total revenue effect of behavioral and economic interactions should
be taken into account.
DIFFERENCES BETWEEN THE ADMINISTRATION AND THE CONGRESSIONAL TAX EXPENDITURE LISTS
Definitional Issues
Despite the general agreement that exists about which provisions in the tax code represent tax expenditures, some cases are not clear-cut. Depending on how the basic tax rules are defined, certain provisions may or may not be considered tax expenditures. For example, the Accelerated Cost Recovery System (ACRS) is counted as a tax expenditure by the Congressional Budget Office and the Joint Committee on Taxation, but not by the Administration. Because the CBO and the JCT assume a different set of basic tax rules than does the Administration, the CBO/JCT list includes 13 provisions not included by the Administration.
The most important distinction between the Congressional and Administration baseline, or reference, tax rules is that the CBO and the JCT use a broader definition of income to define the tax base. Under the Congressional reference tax rules, most income, from whatever source, is assumed to be subject to tax. Any provision that reduces this income measure or reduces the tax otherwise payable is considered a tax expenditure.
The Administration takes a different approach in defining tax expenditures. Under the current Treasury rules, a provision must satisfy two conditions in order to be classified as a tax expenditure:
These conditions obviate the need to define the base of a conventional income tax. Various provisions are compared to the set of general rules currently in the tax code in order to determine whether they are "special." Although the methods for defining tax expenditures used by the CBO and the JCT and the Treasury are similar, they result in differences when a general rule in current tax law, such as ACRS, differs from the rule that prevails under the JCT/CBO definition of the basic income tax rules.
Measurement Issues
The CBO and the JCT estimates of tax expenditures are based solely on
the amount of revenue that the federal government forgoes as a result of
special provisions in the tax code. In contrast, "Special Analysis G" of
the 1984 budget presents estimates of tax expenditures calculated according
to the "outlay equivalent" concept, as well as the traditional revenue
loss estimates. The outlay equivalent approach estimates a tax expenditure's
cost as the amount of direct outlays that would be required to provide
the same after-tax benefit. Outlay equivalents are estimated in a similar
manner to revenue loss estimates, except that they are often increased
to reflect the fact that a comparable outlay program would result in additional
taxable income. The Administration has added this information because the
outlay equivalent approach provides estimates of tax expenditures that
more closely correspond to estimates of direct expenditures.
TAX EXPENDITURE BUDGETS IN OTHER COUNTRIES
Government analysts in several countries have developed tax expenditure lists to help emphasize the total level of government resources devoted to various sectors of their economies and to provide more information for long-term planning. The Federal Republic of Germany was the first country to supply a comprehensive list of tax subsidies in its budget documents, after a 1967 law required biennial reports on direct and tax subsidies. The United States has published annual tax expenditure lists since 1968 and has included a list in its budget documents every year since 1976, as required by the Congressional Budget Act of 1974.
In the 1970s, high deficits forced several other governments to use new institutional procedures, such as tax expenditure budgets, to help control government spending. Austria has published an annual report on direct and tax subsidies similar to the German report since 1978. Canada, the United Kingdom, France, Spain, and Australia first published tax expenditure lists or more general lists of tax reliefs and incentives in 1979 and 1980. In Japan, estimates of "special tax provisions" (mainly tax expenditures) are now usually provided to the legislature at budget time, even though these estimates are not required by law. Government tax analysts have also begun to develop tax expenditure lists in Belgium, Ireland, the Netherlands, New Zealand, and Sweden.
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