What’s Wrong with the Tax Code? Tax Expenditures

 

Congress just voted to show the nation's appreciation to U.S. Olympic and Paralympic athletes by not taxing the prize money they receive for winning a gold, silver, or bronze medal. The votes in both the Senate and the House were nearly unanimous. After all, who doesn't love these dedicated souls and the acclaim they bring to our country?

Even so, Congress should not have granted this special exemption. Not because it is an undesirable giveaway to the athletes, but because of the way that it gives to the athletes. If we want to reward our heroes, we should do so directly rather than by tax benefits — a technique that is neither transparent nor equitable.

In U.S. budget lingo, this Olympic exemption is known as a "tax expenditure," a revenue loss that results when certain types of income are taxed at a preferential rate or given a special exclusion, exemption, or deduction from gross income. Other examples of tax expenditures are the exemption of interest on municipal bonds and the array of credits, deductions, and deferrals for the real estate industry.

The Government Accountability Office estimates that in 2015, tax expenditures represented $1.23 trillion in lost revenues, an amount that is never reported in the government's annual financial statements as either an addition to costs or a reduction from revenues. This dollar loss is hardly insignificant compared with the government's $3.86 trillion in direct expenditures and its net deficit of $520 billion.

When lawmakers use tax expenditures rather than direct spending, they appear to be guardians of taxpayer dollars while still funding their pet causes as they grant exemptions to special classes of taxpayers. The biggest danger is the loss of budget transparency, which is essential to government oversight.

Once incorporated into the tax code, tax expenditures are not included in future year agency budget proposals, are not subject to routine Office of Management and Budget reviews, and need not go through the usual congressional appropriation process. This opens the door to spending without accountability.

Tax expenditures may also allocate the benefits in ways that make little sense. The U.S. Olympic Committee will award more than $2 million to Olympic and Paralympic medalists this year - $25,000 for gold, $15,000 for silver, and $10,000 for bronze. A gold medal "professional" athlete, who (owing to endorsement or other outside revenues) pays taxes at the maximum rate of 39.6 percent, would get a tax break of $9,900 on a $25,000 award. By contrast, a college athlete with no outside earnings and in one of the lowest tax brackets would likely save no more than $1,750. Both keep their $25,000, but the benefit of the exemption is significantly less for the athlete who needs the financial assistance more.

Tax expenditures do have a place in the federal tax code. They help achieve policy goals that likely could not be realistically achieved with direct spending. But as a default approach, the trend is troubling. This type of tax break epitomizes so much of what is wrong with our tax code. It is what enabled Donald Trump and those like him to pay little or no income taxes.

At the very least, tax expenditures demand enhanced scrutiny and greater transparency. One step in the right direction is a proposal by the Federal Accounting Standards Advisory Board, the board that establishes accounting and reporting standards for the federal government at large and each of its federal departments and agencies.

The proposal, which is now out for public comment, would require the federal government to disclose in its annual financial statements the impact of tax expenditures on the government's tax collections and financial condition. The government would have to include examples of tax expenditures, a description of how they affect both the budget and the year-end annual report, and information about how detailed data on tax expenditures can be obtained from other sources, such as the Treasury Department's annual report on tax expenditures.

If Congress wants to supplement the cash awards granted by the Olympic Committee, so be it. Arguably, the athletes are deserving, and it won't break the budget. But let's do it in a way that will highlight — not hide — the true cost.


Michael Granof’s op-ed originally appeared in The Philadelphia Inquirer.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

About The Author

Michael Granof

Professor of Accounting, McCombs School of Business

Michael Granof received an A.B from Hamilton College, an MBA from Columbia University, and a Ph.D. from the University of Michigan. His research...

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