According to the sum of U.S. Department of the Treasury estimates for fiscal year 2009, almost $1 trillion in federal revenue was forgone due to tax exclusions, credits, deductions, deferrals, and preferential tax rates--legally known as tax expenditures. The revenue that the government forgoes is viewed by many analysts as spending channeled through the tax system. Similar to spending programs, tax expenditures represent a substantial federal commitment in a wide range of mission areas. For fiscal year 2009, the U.S. Department of the Treasury listed a total of 173 tax expenditures, some of which were of the same magnitude or larger than related federal spending for some mission areas. Like mandatory spending programs such as Medicare, many tax expenditures are governed by eligibility rules and formulas that provide benefits to those who are eligible and wish to participate. Since 1994, GAO has recommended greater scrutiny of tax expenditures.
Tax expenditures, if well designed and effectively implemented, can be an effective tool to further federal goals, such as encouraging economic development in disadvantaged areas, financing higher education, and stimulating research and development. However, tax expenditures can contribute to mission fragmentation and program overlap, thus creating the potential for duplication. Moreover, some tax expenditures may be ineffective at achieving their social or economic purposes. Tax expenditures do not compete overtly with other priorities in the annual budget, and spending embedded in the tax code is effectively funded before discretionary spending is considered. Many tax expenditures are not subject to congressional reauthorization. Therefore, Congress lacks the opportunity to regularly review their effectiveness. Periodic reviews could help identify redundancy in related tax and spending programs and determine how well specific tax expenditures work to achieve their goals and how their benefits and costs compare to those of programs with similar goals.
In the case of higher education, the federal government offers seven tax expenditures and nine spending programsgrant and loan programs authorized by Title IV of the Higher Education Act of 1965to help students and their families pay for postsecondary education. In 2005, the number of tax filers claiming a higher education tax credit or tuition deduction surpassed the number of Title IV aid recipients. Perhaps due to the multiple, complex tax provisions, hundreds of thousands of taxpayers in 2005 failed to claim tax incentives or did not claim the most advantageous tax benefit. Simplifying the tax, grant, and loan programs may reduce complexities in higher education financing, including reducing the number of eligible taxpayers that do not claim tax benefits. However, GAO reported in 2008 that Congress had received little information about the roles and effectiveness of the tax and Title IV programs.
To date, the Office of Management and Budget (OMB) has not used its budget and performance review processes to systematically review tax expenditures and promote integrated reviews of related tax and spending programs.
Past GAO reviews of specific tax expenditures have identified options to improve their design and better target resources. For example, in 2010, GAO suggested that Congress modify the Research Tax Credit to reduce windfalls to taxpayers for research spending they would have done anyway. GAO also suggested that Congress convert at least part of the New Markets Tax Credit to a grant program to increase the amount of federal subsidy reaching businesses in impoverished, low-income communities.
Data availability has been a challenge in assessing tax expenditure performance. In the case of the Empowerment Zone, Enterprise Community, and Renewal Community programs, the lack of tax benefit data limits the ability of the Department of Housing and Urban Development (HUD) and the Department of Agriculture to evaluate the overall mix of grant and tax programs to revitalize selected urban and rural communities. In response to GAO recommendations, HUD and the Internal Revenue Service (IRS) collaborated to share data on some program tax credits. However, the IRS data do not tie the program tax incentives to specific designated communities, making it difficult to assess the impact of the tax benefits.
Coordinated reviews of tax expenditures with related federal spending programs could help policymakers reduce overlap and inconsistencies and direct scarce resources to the most effective or least costly methods to deliver federal support.
In 2005, GAO recommended that the Director of the Office of Management and Budget in consultation with the Secretary of the Treasury take specific actions to ensure that policymakers have necessary information to exercise scrutiny of tax expenditures:
The Executive Branch had made little progress in implementing similar recommendations that GAO made in 1994, and, OMB, citing methodological and conceptual issues, disagreed with GAO's 2005 recommendations. However, in its fiscal year 2012 budget guidance, OMB instructed agencies, where appropriate, to analyze how to better integrate tax and spending policies that have similar objectives and goals. Such analysis could be useful in identifying redundancies.
Improving tax expenditure performance or eliminating tax expenditures could reduce revenue losses, potentially by billions of dollars. For example, improved designs may enable individual tax expenditures to achieve better results for the same revenue loss or the same results with less revenue loss. Also, reductions in revenue losses from eliminating ineffective or redundant tax expenditures could be substantial depending on the size of the eliminated provisions. Whether and how much federal revenues would increase from improving tax expenditures' performance or eliminating them also would depend on whether and how much Congress might adjust overall tax rates as tax expenditure inefficiencies are addressed. GAO believes that tax expenditure performance is an area that would benefit from enhanced congressional scrutiny as Congress considers ways to address the nation's long-term fiscal imbalance.
The information contained in this analysis is based products listed under the "Related GAO Products" tab and GAO's work following up on the recommendations from those products.
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