Revisiting the Distribution of Tax Expenditures

Tax expenditures are a frequent subject of this blog, as they are less visible than government spending due to the tax code's great complexity. But these provisions are costly, estimated at $1.3 trillion in forgone revenue in 2013 by the Joint Committee on Taxation, and should be better seen as government spending. However, due to the progressiveness of the tax code, most tax expenditures especially benefit upper income taxpayers.

In recent weeks, the Tax Policy Center has updated their distributional analysis of the home mortgage interest deduction and many other tax expenditures. The mortgage interest deduction is often defended as promoting middle class homeownership, but as the graph below shows, many of the benefits go to those making over $200,000. The tax provision is also criticized by many economists as discouraging saving by providing a windfall to large mortgages.

That the mortgage interest deduction is regressive is not particularly surprising; rather, it is generally the norm among most tax expenditures. The state and local tax deduction, the charitable deduction, and preferential rates for dividends and capital gains all disproportionately benefit higher income earners. Some credits are exceptions, most notably the child tax credit (CTC) and the earned-income tax credit (EITC), but tax expenditures are generally regressive.

^{Source: Tax Policy Center}

Comprehensive tax reform could reform or eliminate many tax provisions that are not achieving their intended purpose, or doing so ineffectively. Many bipartisan plans have looked at the mortgage interest deduction and changed the provision to make it less costly and more beneficial to lower income Americans. The Fiscal Commission replaced the mortgage interest deduction to a 12 percent non-refundable credit, capped at $500,000 of mortgage debt. The Domenici-Rivlin plan would replace the deduction with a 15 percent refundable credit, limited to $25,000 of mortgage interest. Both plans wouldn't provide the credit for second residences.

Tax reform has the potential to make our tax code more efficient while raising more revenue. We hope lawmakers are willing to turn to tax reform in a smart deficit reduction package.