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Tax Expenditures: Revenue Loss Versus Outlay Equivalents
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© TAX ANALYSTS. Reprinted with permission.
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Tax expenditures refer to the revenue losses attributable to provisions of the federal tax laws that deviate from a "normal" tax on income. Although there are debates over precisely what a tax expenditure is, many exclusions, deductions, credits, preferential rates, and deferrals of tax liability other than those necessary to calculate income correctly or to provide a basic exemption from taxation are considered tax expenditures. Common examples of tax expenditures are itemized deductions for charitable contributions and the employee exclusion from taxation for employer-provided health benefits.
The Treasury employs two main methods of evaluating the cost of these tax benefit programs. The first method is to simply estimate the revenue forgone. The second is to estimate the "outlay equivalent" in theory, the value of the same program were it administered as a taxable federal outlay to recipients. The two approaches end up counting different items as tax expenditures in part by whether or not they could ever be a direct outlay administered by an expenditure agency. Our focus here is on another primary difference: that some of these tax deductions and credits are themselves nontaxable. Thus, the outlay equivalent takes into account that the subsidy itself might be nontaxable, which adds to its value. For instance, a nontaxable tax credit like the child tax credit is more valuable to a taxpayer than a taxable subsidy provided as a direct expenditure or a tax subsidy.
Consider, for example, a wage earner who is in the 25 percent income tax bracket. He would need to earn $100 to finance what could be provided with a $75 nontaxable tax credit. The $75 figure is what tends to show up as the traditional revenue estimate, where the "outlay equivalent" reflects the $100 value. However, note that the term "outlay equivalent" can be misleading as well since many outlays are themselves nontaxable. Publicly subsidized education is an example. The outlay side of the budget may report $75 of saving to the taxpayer for getting $75 of additional public education expense, but that estimate by itself also understates the $100 value to the 25-percent-bracket taxpayer.
The table below compares the revenue loss and outlay equivalent for several well-known tax subsidies or expenditures. The ratio of outlay equivalent to revenue loss rises when the tax rates of beneficiaries are higher. Thus, the ratio is lowest for programs like the earned income tax credit, much of which goes to low-income families.
The Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, provides independent, timely, and accessible analysis of current and emerging tax policy issues for the public, journalists, policymakers, and academic researchers. For more tax facts, see http://www.taxpolicycenter.org/taxfacts.