The Hidden Progressivity of the U.S. Tax Code: Despite Tax Expenditures, U.S. Tax Code Remains Progressive

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Photo: Emily Metcalf
money
Photo: Emily Metcalf

Washington, D.C., January 13, 2014—A new study from the nonpartisan Tax Foundation clears up misconceptions about the progressivity of the U.S. tax code. According to the study, examining the distribution of complicated and often subjectively defined tax expenditures without also looking at the distribution of income taxes can lead to the false belief that tax expenditures cause the U.S. tax code to favor high-income earners over low-income earners.

“Although higher income earners do pay more in income taxes, the benefits received from tax expenditures don’t outweigh the contributions,” says Tax Foundation Fellow Michael Schuyler. “When looking at 11 of the largest expenditures, and also including personal exemptions and the standard deduction, low-income tax filers claim about twice the tax expenditures relative to income as middle- and upper-income tax filers.”

The study found that:

  • While lists of tax expenditures can sometimes be helpful in highlighting tax preferences, they are not a shortcut to tax reform. Many current tax expenditures would not be considered tax expenditures in a neutral tax system.
  • The distribution of tax expenditures is not an accurate guide to understanding the progressivity of the federal income tax system, partly due to the structure of the tax expenditures list.
  • Most distributions of tax expenditures do not include the personal exemption and standard deduction, although a strong case can be made that they are very large (and desirable) tax expenditures. This shifts the distribution of tax expenditures significantly.
  • When we model eleven major tax expenditures using the Tax Foundation’s Taxes and Growth Model, we estimate that, as a percentage of income, low-income and high-income taxpayers receive the largest amount of tax expenditures (9.4 percent and 10.4 percent, respectively).
  • When we also count the personal exemption and standard deduction as tax expenditures, low-income taxpayers receive the largest amount (22.6 percent share of income) and high-income taxpayers receive an amount that is similar to those for middle-income taxpayers (10.9 percent).

This examination of tax expenditures is timely because there is much interest on Capitol Hill in giving up some tax expenditures in return for lower tax rates. In order for lawmakers to correctly asses the current state of the tax code, it’s important that they understand the full picture of expenditures and income taxes together.

The full report, Baked In the Cake: Why the Progressivity of the Income Tax Isn’t Visible in the Distribution of Tax Expenditures, is available online.

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