Monday, November 30, 2009

What are tax expenditures and who benefits from them?

A tax expenditure is the amount of money that a government forfeits by giving a tax break for a certain activity or transaction. In the U.S., tax expenditures include the ability to deduct mortgage insurance from your income, the reduced tax rates on capital gains and dividends and the fact that the value of health insurance that your employer provides for you is excluded from your income. In terms of economics, a tax expenditure is the same thing as an actual subsidy, because the government could have taxed the activity or transaction and used the money for something else.

The Urban-Brookings Tax Policy Center provides information on the 12 largest tax expenditures in the U.S. The largest tax expenditure is the one for health insurance.

Tax expenditures are also not distributed progressively, meaning that the bulk of tax expenditures benefit the richest, rather than the poorest Americans. This should be weighed against the fact that a number of Americans pay zero or negative net taxes (the latter if they are recipients of the Earned Income Tax Credit). Our friends at the Tax Policy Center also provide an article discussing the distribution of the expenditures. Overall, all tax expenditures benefit those in higher income groups. If tax expenditures were eliminated, the after-tax income of the bottom quintile would decrease by 6.5% (mainly due to the elimination of the child tax credit and earned income tax credit). In contrast, the income of the top quintile would decrease by 13.5%.

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