Tax expenditures are a significant part of America’s tax code, playing a major role in the country’s economy. Sometimes referred to broadly as “loopholes” or “tax breaks”, tax expenditures are preferences built into the code for certain individuals and businesses. Tax expenditures come in a variety of forms including:
- Tax exclusions allow certain categories of income to go untaxed (e.g., active duty pay earned by military personnel in a combat zone is not subject to taxation).
- Tax exemptions shield certain assets, or the income taxpayers earn from certain assets, from taxation (e.g., individuals can exempt interest earned from some state or local bonds, and some charitable organizations are exempt from paying income and property taxes).
- Tax deductions allow taxpayers to deduct expenses from their taxable income (e.g., deduction on medical expenses in excess of 7.5 percent of individual income).
- Tax credits reduce the amount of taxes owed. Refundable credits provide cash back to the taxpayer when taxes owed are less than the credit due.
From an economic standpoint, tax expenditures are very similar to government spending. They are policy choices intended to encourage certain behaviors, and have significant influence over decisions made by individuals and businesses in the economy. For example, the mortgage interest deduction was intended to support homeownership, and the exclusion of employer-sponsored health insurance was meant to support companies covering their employees’ health care. In this way, expenditures are, in essence, spending through the tax code.
It is difficult to precisely track and evaluate the efficiency of tax expenditures, as many beneficiaries might have engaged in the desired behavior (e.g., buying a home) without the added tax incentive. In 2024, tax expenditures totaled $1.9 trillion — which is more than the government spends on many major programs.
In 2024, just five tax provisions accounted for over $1.1 trillion – which is more than the government spent on Medicare or defense that year. Those tax expenditures include:
- Exclusion of pension contributions and earnings ($395 billion)
- Exclusions of and reductions on dividends and long-term capital gains ($283 billion)
- Exclusion of employer contributions for medical insurance and care ($218 billion)
- Child Tax Credit ($127 billion)
- Subsidies for insurance purchased through health benefit exchanges ($114 billion)
Other Helpful Resources:
- What are tax expenditures and how are they structured? — Tax Policy Center
- What Are Tax Expenditures — Tax Foundation
- Tax Expenditures — Congressional Budget Office
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Further Reading
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