NCPA - National Center for Policy Analysis

The Flawed Concept of Tax Expenditures

February 13, 2002

A consumption-based tax system, says Bruce Bartlett, would eliminate the overtaxation of capital.

Currently, for example, corporate profits are taxed at the corporate level and again as personal income when distributed as dividends to shareholders. With the exception of 401(k) plans, IRAs and the like, individuals save out of their earnings after paying income taxes, and then are taxed on the interest, or dividends and capital gains, from their invested savings.

Thus a big stumbling block to a consumption-based system is the notion that an "ideal" tax system should double tax investment and saving.

  • That concept underlies the so-called tax expenditures budget, published every year in the president's budget, that lists all deviations from a "normal" tax system.
  • All provisions of the law that reduce taxes on saving and investment are considered tax expenditures or "loopholes."
  • Until the tax expenditures budget is revised, any improvement in the Tax Code toward a consumption base will be viewed as widening tax loopholes -- including accelerated depreciation of business investment in plant and equipment, or reducing the capital gains tax.

In its 2003 budget, the Bush administration says items on the tax expenditures list need to be updated as conceptions of what a normal Tax Code looks like change -- thus the budget makes no calculation of tax expenditures for the estate and gift tax, since Congress has voted to repeal this tax in 2010.

It is also considering addition of "negative" tax expenditures -- provisions that raise taxes above what would exist under a normal system. And it is looking into an alternative tax expenditures presentation based on a consumption-based tax system.

These reforms would greatly improve the tax expenditures budget.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, February 13, 2002.


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