restricted access Tax "Expenditures" and Welfare States: A Critique
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Tax "Expenditures" and Welfare States:
A Critique

Recently several scholars have argued that tax preferences are equivalent to welfare spending, and that our understanding of welfare states should be revised to take tax preferences into account. A tax preference is a provision in the tax code (an exemption, deduction, or credit) by which taxpayers are able to reduce their tax obligations in return for behaving in some specific way. For example, the mortgage interest tax deduction allows taxpayers to deduct the interest on their mortgage payments from their taxable income, thereby reducing the taxes they would otherwise owe as long as they are making mortgage payments.

The tradition of equating tax preferences with welfare spending is several decades old. Stanley Surrey, then assistant secretary of the Treasury, compiled a list of tax preferences for the first time in the 1960s, arguing that they should be examined on the same basis as welfare spending. His argument was that whether welfare is accomplished by first transferring revenue from society to the state and then back to society (welfare spending), or whether it is accomplished by foregoing the tax revenue in certain targeted ways (tax preferences), is equivalent in accounting terms, and should therefore be analyzed equivalently. Surrey insisted on calling tax preferences "tax expenditures," to highlight their supposed similarity to social expenditures, and this terminology persists today. In this paper, for reasons that will become clear, I avoid the "tax expenditure" terminology and use the term "tax preferences." [End Page 251]

One of Surrey's reasons for focusing on tax preferences was that they disproportionately benefited the upper tax brackets. By shining bureaucratic and political light onto them he hoped to bring the practice of tax preferences in line with public opinion regarding the operation of the tax code, and preferably to replace them with direct spending or to eliminate some of them altogether. The Treasury began to compile annual lists of tax preferences, and tax preferences became subject to congressional scrutiny. Surrey's efforts and his list called attention to the large amounts of revenue that were lost because of tax preferences, and in the intervening decades they have become only more important.1 Surrey and scholars who followed in his footsteps identified a host of reasons why direct spending was preferable to tax preferences, as summarized in a recent article: "Tax expenditures increase tax complexity and compliance burdens (administrative concerns); they are more opaque and esoteric than direct expenditures and so relatively more immunized from public debate or scrutiny (visibility concerns); they are more likely than direct expenditures to have regressive first-order effects (equity concerns); their uses may evolve in unexpected ways (predictability concerns); and they may stimulate unproductive activity or reward behavior that would have occurred anyway (efficiency concerns)."2 Although these claims have been questioned by others, many tax practitioners inside and outside government continue Surrey's call to replace tax preferences with direct spending.

In the 1990s several scholars brought this analytical tradition into policy history, with Christopher Howard and Jacob Hacker being the most well-known proponents of it. Howard's brilliant and path breaking book, The Hidden Welfare State, carefully traces the history of four major tax preferences in the American tax code: the tax preferences for home mortgage interest and employer pensions as well as the Earned Income Tax Credit and the Targeted Jobs Tax Credit.3 Howard shows that the politics of tax preferences are distinct from the politics of social spending in that tax preferences are introduced with less struggle than direct welfare spending, often with the support of conservative politicians, and without as much input from interest groups.4 Howard explicitly anticipates the argument that Jacob Hacker would later make famous,5 that tax preferences for health and pensions led to the proliferation of a "private" welfare state in the United States, which then undermined attempts to develop a public welfare state.6

Howard has recently pushed this argument to its limits, arguing that "the American welfare state is actually 40 percent larger than commonly believed. Imagine a map of the United States that started on the Eastern seaboard and [End Page 252] extended west to the...