Front Matter Page

Western Hemisphere Department

Contents

• Summary

• I. Introduction

• II. Underlying Economic Framework

• III. Tax Expenditures

  • 1. Background

  • 2. Recent developments

  • 3. Further areas for reform

    • a. Exclusion of employer contributions to medical insurance and health care

    • b. Exclusion of employer plan pension contributions and earnings

    • c. Deduction of mortgage interest on owner-occupied housing

    • d. Deduction of property tax on owner-occupied housing

    • e. Deduction for state and local income taxes

    • f. Carryover basis of capital gains at death

    • g. Exclusion of social security benefits

• IV. Conclusion

• Text Tables

  • 1. Impact of Tax Reform on Projected Revenue Losses From the Largest Tax Expenditures

  • 2. International Comparison of Selected Tax Expenditures

• References

Summary

This paper considers the merits of reducing or eliminating some specific tax expenditures, which, in the process, could help reduce the U.S. federal budget deficit.

The paper begins by pointing out that a strong case can be made on efficiency grounds for financing even a temporary increase in expenditures by tax increases rather than by bond issues. This conclusion is based on the observation that savings decisions in the United States are already influenced by various taxes and other impediments, and that any further borrowing by the Government to finance current expenditures will therefore exacerbate these pre-existing influences, resulting in significant welfare losses.

Following a discussion of recent tax expenditure developments, in which it is noted that the Tax Reform Act of 1986 has reversed the tendency for tax expenditures to grow in importance, and in which a comparison with the practice in other Group of Seven countries is made, the paper evaluates the case for eliminating seven specific tax expenditures that are still in place. Two general conclusions emerge from this evaluation. The first is that tax expenditures are heterogeneous and should therefore be individually evaluated. The second is that it should be possible, by reducing or eliminating individual tax expenditures, to produce further significant reductions in the U.S. federal deficit while at the same time enhancing economic efficiency.

In particular, analysis indicates that the following are examples of the type of tax expenditures that could be either reduced or eliminated: the exclusion of employer contributions to medical insurance and health care; the deduction of mortgage interest on owner-occupied housing; the deductions for both property taxes and state and local income taxes; the carryover basis of capital gains at death; and the current exclusion of some social security benefits. An example of a tax expenditure that, it could be argued, should be retained is the exclusion of employer plan pension contributions and earnings because this exclusion may contribute to an increase in national savings.