These charts by the Congressional Budget Office show how tax expenditures… (Congressional Budget Office )
A new Congressional Budget Office report on the cost and beneficiaries of 10 of the largest federal tax breaks includes one surprising factoid that could make it harder for lawmakers to simplify the tax code by winnowing the thicket of credits, deductions and exemptions.
The report published Wednesday estimates that these 10 breaks add up to $900 billion annually, or roughly two-thirds of the value of the more than 200 "tax expenditures" in the code. (Interesting side note: The CBO cautioned lawmakers not to assume that canceling these breaks would bring in $900 billion in revenue. That's because taxpayers would find other ways to lower their tax bills.)
The 10 top breaks fall into four categories. The first is income that's excluded from taxation, composed of employer-paid health benefits, pension contributions and earnings, capital gains accrued by assets before they're inherited and (most) Social Security and railroad retirement benefits. The second is itemized deductions, led by state and local taxes, mortgage interest and charitable contributions. The third is income taxed at a lower rate, to wit, capital gains and dividend income. The final category is tax credits, or amounts deducted from a person's tax bill, the two largest of which are the earned income tax credit and the child tax credit.
The CBO looked at which taxpayers took advantage of these exclusions, deductions, preferences and credits, and not surprisingly, most of the savings flowed to taxpayers in the wealthiest quintile -- that is, the 20% with the highest incomes. That fifth of the taxpaying public collected a little more than half of the savings, according to the CBO.
The surprise came when the CBO looked at which taxpayers received the biggest benefit from the breaks relative to their income. It found that for taxpayers in the bottom fifth, those tax breaks amounted to almost 12% of their after-tax income. For those in the top fifth, the value was less than 10% of their after-tax income. For the 60% in between, the value was between 7% and 8%.
Put another way, the study found that the comparatively small tax breaks that help taxpayers at the bottom of the economic ladder have a more significant effect on their incomes than the considerably larger write-offs have on the incomes of those at the top.
There may not be much overlap between the breaks used by the highest- and lowest-income households beyond the child tax credit. Members of the former group aren't eligible for the earned income tax credit, and most of their Social Security benefits are taxed. Those in the latter group are far less likely to itemize deductions, have capital gains and dividend income and have employer-paid health benefits.
But that diversification of benefits may only make it harder for reformers to overhaul the tax code. As the report shows, getting rid of these 10 breaks would raise tax bills across the board. Lawmakers could try to offset those increases by lowering tax rates, but that would help higher incomes more than lower ones. In fact, it wouldn't do anything at all for the lowest-income users of the earned income tax credit, who receive more back from the IRS than they pay in taxes.
Tax simplification is devoutly to be wished for all sorts of reasons. But it's politically challenging because eliminating the breaks and loopholes that clutter the code will leave some people with higher tax bills even if Congress cuts rates significantly. And as the CBO's report shows, the potential losers include both the rich and the poor.