Tax expenditures are reductions in tax liabilities that result from:
- excluding or exempting items from gross income (“tax exclusions”);
- deducting items from either gross income or adjusted gross income (“tax deductions”);
- granting preferential tax rates for certain items of income (“tax preferences”);
- applying credits to directly reduce taxes owed (“tax credits”);
- applying “credits” that exceed tax liability resulting in payments to taxpayers (“refundable tax credits”); or
- deferring tax liability on certain types of income (“tax deferrals”).
In the context of budgeting, these are collectively referred to as “tax expenditures” because the government foregoes revenues it would have otherwise collected. Colloquially, they are often referred to as “tax preferences” and “tax breaks,” or more negatively as “tax loopholes” by those who disagree with particular provisions.
In effect, tax expenditures are “spending on the revenue side” of the federal budget because policymakers have written into the Internal Revenue Code[1] provisions that reduce federal taxes in order to achieve specific policy outcomes such as encouraging home ownership, retirement savings, capital investments, or employer sponsored health insurance.
In some cases, tax expenditures may also be viewed as the revenue equivalent of spending entitlements. For example, similar to Americans age 65 and older being entitled to Medicare hospital insurance coverage (on the spending side of the federal budget), employees who receive group health insurance from their employers are entitled to exclude employer-paid premiums from their gross income. In both examples, eligible individuals are legally entitled to specific benefits—one on the spending side of the budget and the other on the revenue side.
Tax expenditures are as varied in purpose and operation as programs on the spending side of the budget. Following is a summary of the largest tax expenditures in fiscal year 2023 (Joint Committee on Taxation projections).
Largest Individual and Corporate Tax Expenditures in FY 2023[2]
| Individual or Corporate Tax Expenditure | $ in billions |
| Exclusion of Pension Contributions and Earnings | $345 b |
| Exclusion of Employer Contributions for Healthcare and Long-Term Care | $190 b |
| Reduced Tax Rate on Dividends and Long-term Capital Gains | $145 b |
| Credit for Children and Other Dependents | $121 b |
| Earned Income Tax Credit | $70 b |
| Subsidies for insurance purchased through health benefit exchanges | $70 b |
| Exclusion of Capital Gains at Death | $59 b |
| 20-percent deduction for qualified business income | $57 b |
| Exclusion of Untaxed Social Security and Railroad Retirement Benefits | $48 b |
| Reduced Rate on Active Income of Controlled-Foreign Corporations | $45 b |
| Deduction for Charitable Contributions other than education and health | $40 b |
| Exclusion of Capital Gains on Sales of Principal Residences | $40 b |
| Depreciation of Equipment in Excess of ADR[3] | $39 b |
| Deduction for Mortgage Interest, Owner-Occupied Residences | $29 b |
| Individual Retirement Accounts, Traditional and Roth | $26 b |
| Exclusion of Nonbusiness State and Local Government Taxes | $24 b |
| Exclusion of Interest on Public Purpose State and Local Government Bonds | $22 b |
| Credit for Increasing Research Activities | $17 b |
| Exclusion of Amounts Received under Life Insurance Contracts | $15 b |
| Deduction for Foreign-Derived Intangible Income for Business within the U.S. | $15 b |
| Credits for Tuition for Post-Secondary Education | $14 b |
| Exclusion of Veterans’ Disability Compensation | $12 b |
| Credit for Low-Income Housing | $12 b |
[1] Title 26 of the U.S. Code.
[2] FY 2022 estimates, rounded. Jt. Comm. On Taxation., Estimates of Federal Tax Expenditures for Fiscal Years 2022-2026, Table 1 (2022). See also Off. of Mgmt. & Budget, Exec. [Off.] of the President, Budget of the United States Government, Fiscal Year 2023, Analytical Perspectives – Tax Expenditures, (2022); Cong. Budget Off., The Distribution of Major Tax Expenditures in 2019 (Oct. 27, 2021); and Dept. of the Treasury, Tax Expenditures, accessed June 19, 2022 at https://home.treasury.gov/policy-issues/tax-policy/tax-expenditures.
[3] Asset Depreciation Range: a method set by the IRS for determining the useful life of business equipment and other property.