We tend to think about taxes as a way to pay for government spending. But the tax code is increasingly being used for its own kind of backdoor spending.
We all know that the tax code is full of deductions, credits, exemptions, and other tax breaks and loopholes. Many of them are really no different than spending programs. For example, the American Opportunity Tax Credit (AOTC) offers money to people attending college just like Pell Grants do. However, the AOTC provides the funds in the form of a tax credit. So, while Pell Grants are considered a spending program, the AOTC is not, even though they both essentially have the same effect.
With more scrutiny being given to traditional government spending, tax expenditures (the term some economists use for spending through the tax code) have become more appealing to policymakers. In fact, tax expenditures now account for $1.6 trillion in lost revenue annually. That’s the same as if $1.6 trillion in new spending was added to the budget.
If tax expenditures were considered part of the federal budget, they would represent over a quarter (28%) of government spending. However, spending through the tax code currently does not receive the same amount of scrutiny as traditional spending and is not reviewed on a regular basis.
The plethora of tax expenditures makes the tax system more complex and reduces fairness. It also distorts decision-making by businesses and individuals because choices are made based on their tax impact instead of the economic consequences.
With tax reform on the agenda in Washington, tax expenditures must be addressed. Eliminating or limiting these tax breaks can make our tax system more economically competitive and reduce deficits. See more on the need for fundamental tax reform and how it can help fix the debt.