ECONOMIC AND DISTRIBUTIONAL EFFECTS OF TAX EXPENDITURE LIMITS
Len Burman, Eric Toder, Daniel Berger, and Jeffrey Rohaly
Tax expenditures are special tax rules in the form of deductions, exclusions, credits, and favorable rates that benefit selected activities, industries, or groups of taxpayers. Since Stanley Surrey originally popularized the concept in the 1970s, tax policy experts have recognized that special tax benefits represent a form of public spending disguised as tax reductions. Because of this, it is often easier to enact tax breaks to promote policy agendas than to enact equivalent direct spending programs that are more transparent. As a result, many tax expenditures are poorly targeted, distort economic choices of households and businesses, and make the tax law more complicated. Reducing or eliminating many of them to pay for lower rates, deficit reduction, or higher priority spending programs has long been a goal of tax reformers.
Tax expenditure reduction has proven politically difficult, however. The most costly tax expenditures, including the exclusion for employer-sponsored health insurance, itemized deductions for home mortgage interest, charitable contributions, and state and local taxes, and the exemption of interest on municipal bonds benefit many taxpayers and have the support of powerful constituencies. As an alternative, policymakers and commentators have expressed interest in approaches, analogous to direct spending caps, to limit the costs of tax expenditures without targeting single provisions.
This chapter examines the effects of alternative ways of imposing global limitations on groups of tax expenditures that benefit individual taxpayers. We begin by providing some general background on the adverse effects of tax expenditures and past efforts of tax reform proposals to reduce them. We review existing limits on tax expenditures— the alternative minimum tax and the limitation on itemized deductions—and discuss alternative and more comprehensive limitations that would be preferable to existing ones. We then provide estimates of the effects of alternative global limitations on federal revenues and on how much tax rates could be reduced while maintaining revenue neutrality. We estimate the effects of alternative limitations on the distribution of tax burdens, marginal tax rates on capital and labor income, and incentives to engage in tax-subsidized activities. A final section concludes.