Tax Expenditures are not Loopholes

By :: April 22nd, 2011

George Orwell once wrote: “If thought corrupts language, language can also corrupt thought.” I am reminded of Orwell and his deep concern with the misuse of language for political ends when I see pols of both parties label tax expenditures as “loopholes” or “earmarks.”

The House Budget resolution promises an individual tax reform that “simplifies the broken tax code, lowering rates and clearing out the burdensome tangle of loopholes that distort economic activity.” The Fact sheet describing President Obama’s new budget framework calls for “individual tax reform that closes loopholes and produces a system which is simpler, fairer, and not rigged in favor of those who can afford lawyers and accountants to game it.” The bipartisan National Commission on Fiscal Responsibility and Reform notes that the tax system is riddled with tax expenditures and adds, “These earmarks not only increase the deficit, but cause tax rates to be too high.”

The Congressional Budget Act of 1974 defines “tax expenditures” as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability.” The late Stanley Surrey, a Harvard law school professor turned top Treasury tax official, promoted the use of the term “tax expenditures” to highlight the increased use of the federal income tax as a vehicle for Congress to enact backdoor spending. And they are very big: the annual revenue loss from these provisions now totals more than $1 trillion.

But the largest tax expenditures are not loopholes or earmarks snuck into the law in the dead of night to benefit a shadowy handful of super-wealthy individuals or well-connected corporations. Rather, they benefit tens of millions of taxpayers. Among the biggest: itemized deductions for home mortgage interest, charitable contributions, and state and local taxes, exemption of income accrued within tax-preferred retirement saving accounts, and the exemption from tax of employer contributions to health insurance plans. IRS data show that 39 million taxpayers claimed deductions for home mortgage interest and charitable contributions in 2008, and 35 million deducted state and local income taxes.

Loopholes and earmarks are something entirely different. That great source of all knowledge, Wikipedia, defines a loophole as “a weakness or exception that allows a system, such as a law or security, to be circumvented or otherwise avoided.” From the same source, an earmark is “a legislative provision that directs approved funds to be spent on specific projects, or that directs specific exemptions from taxes or mandated fees.” When people think of “tax loopholes”, they rightly think of sophisticated transactions that enable the well-advised to avoid taxes that Congress wanted them to pay. When they think of “tax earmarks”, they rightly think of narrow and highly technical provisions slipped into legislation at the behest of a compliant Member of Congress. These provisions—once dubbed “rifle shots” — benefit only a few very specific taxpayers (sometimes only one), and are the tax equivalent of appropriated funds given to a single project or congressional district.

Labeling broad provisions that are easy to use and benefit millions of taxpayers as “loopholes” or “earmarks” exaggerates the benefits of tax reform. But worse than deceiving others is the self-deception this misuse of language produces. There are strong arguments for paring back or eliminating some of the large and popular tax expenditures and tax expenditures should certainly not get a free pass when Congress is cutting direct spending. And I agree that restructuring and cutting tax expenditures should be a big part of any effort to bring the deficit under control. But let’s not kid ourselves that these cuts will be easy or that cutting back on provisions like the mortgage interest deduction, exemption of employer-provided health insurance, or retirement saving incentives will affect only a few well-advised taxpayers. And let’s also not kid ourselves that we can raise any significant money from tax expenditures without touching these and other large and popular provisions.


  1. Sid F  ::  2:11 pm on April 22nd, 2011:

    Excellent comments, right on the money. All of the so-called “tax expenditures” have been added to the code to address the needs of special groups or for the concept of fairness. Charitiable deductions, for example, are a way of engineering behavior without actually requiring it. Taxpayers are encouraged to engage in socially responsible activities, but have the choice to opt out.

    Because negative politics (vote for me, otherwise my opponent will do _______ to you) is more persuasive than positive politics. Only a fiscal and debt crisis will change things.

    Again, great post.

  2. Fiscal Policy Highlights Around the Net « Donald Marron  ::  5:52 pm on April 22nd, 2011:

    […] Over at the Tax Policy Center, Eric Toder pushes back against the idea that tax expenditures — spending in the tax code — are […]

  3. Michael Bindner  ::  11:58 am on April 23rd, 2011:

    Altering tax expenditures for housing could very well be used to change the mix of housing provided. If the mortgage interest deduction and property tax were traded for a larger tax credit, then families would upgrade their housing more easily as they grow – causing an increase in housing stocks (although some may be rental).

    Ending the deductibility of state income taxes in exchange for ending the state funding responsibility for Medicaid, as both Len Burman and I suggest(rather than expanding state responsiblities, as Ryan suggests) would be welcomed by most states.

    There is no back door way to raise taxes on the wealthy. Citizens for Tax Reform will oppose any cuts to mortgage interest because they do benefit their wealthy donors, so I agree that we should not count on ending tax benefits as the way to raise revenue.

    If revenue is to be raised, one must convince the wealthy that their children are on the hook for the debt, rather than every citizen. Only the next generation of rich people can afford higher taxes without losing spending power. We must also abandon the canard that they “make money.” Most wealth is earned by having the economic power to cut employee salaries to the bone while raising executive pay. Having a tax system that encourages such behavior is not good public policy. Once the wealthy see a familial interest in paying down the debt, we can again pursue sane tax policy.

    Gridlock is actually our friend here, provided the Democrats don’t buy the other canard that letting the 2010 tax cuts expire will hurt the economy. If that were true, their enactment in 1993 would have caused a recession rather than the longest period of growth in American history. Once the GOP realizes that Obama doesn’t have to deal, it will be more likely to negotiate in good faith.

  4. Mike S  ::  12:13 pm on April 24th, 2011:

    Great post. But I’m left wondering how big a proportion each type of expenditure–“loopholes” for businesses versus popular ones like the mortgage interest deduction–constitutes. That is, where can I find a pie chart for the $1 trillion in lost revenue, where it is indicated how much of the 1 trillion goes to what type of expenditure? Thanks!

  5. Vivian Darkbloom  ::  12:29 pm on April 24th, 2011:

    For a recent summary of tax expenditures by category, you can refer to the following generated by the Joint Committee on Taxation. Most people don’t realize this, but the JCT does all the scoring on revenue related aspects of Congressional legislation. Their work is then re-packaged by the CBO together with the spending bits. The JCT should get more credit for the work they do.

  6. Around The Dial – 4/25/11  ::  3:11 pm on April 25th, 2011:

    […] TaxVox muses about the language of tax expenditures. […]

  7. AMTbuff  ::  6:56 pm on April 26th, 2011:

    Labeling broad provisions that are easy to use and benefit millions of taxpayers as “loopholes” or “earmarks” exaggerates the benefits of tax reform.

    Right. Tax breaks that benefit millions of people are part of the tax baseline, not loopholes and not spending programs. Removing such a broad tax break without reducing tax rates is therefore a tax increase, not a reduction in spending. The public agrees with this common-sense interpretation.

    Removing a tax break that affects 20,000 taxpayers could be deemed a spending cut, but removing a tax break that affects 20,000,0000 taxpayers is definitely a tax increase. Policy wonks get so fixated on the mathematics that they cannot see this obvious fact.

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