Don't Mess With Taxes

The richest 20 percent of Americans enjoy more than half of the benefits from 10 major tax breaks.

That's the analysis of the nonpartisan Congressional Budget Office in its report, "The Distribution of Major Tax Expenditures in the Individual Income Tax System," released last week.

The tax breaks -- or expenditures as they are known in legislative circles -- include tax deductions, tax credits, preferential tax rates for certain types of income and income that is excluded from taxes. The CBO grouped the expenditures into four categories:

1. Exclusions from taxable income, which includes employer-sponsored health insurance, net pension contributions and earnings, capital gains on assets transferred at death and a portion of Social Security and Railroad Retirement benefits;
2. Itemized deductions, such as certain taxes paid to state and local governments, mortgage interest payments and charitable contributions;
3. Tax credits, including the Earned Income Tax Credit (EITC) and the child tax credit; and
4. Preferential tax rates on capital gains and dividends.

So why, out of more than 200 individual and corporate tax provisions from which to choose, did the CBO pick these 10 tax expenditures?

Because, says the CBO, they will account for roughly two-thirds of the total budgetary effects of all tax expenditures in fiscal year 2013.

Together they are estimated to total more than $900 billion, or 5.7 percent of gross domestic product (GDP), in fiscal year 2013. Projections over 2014 through 2013 show these 10 tax breaks amounting to $12 trillion, or 5.4 percent of GDP in that stretch.

Biggest winners from the biggest tax breaks: Then there's the matter of just who benefits from the billions and trillions connected to these tax breaks.

"The 10 major tax expenditures considered here are distributed unevenly across the income scale," says the CBO. How unevenly? As noted earlier, the wealthiest 20 percent get most of the benefits.

That's the fiscal analysis way of saying the tax biggest tax expenditures favor the wealthy.

But the richer you are, the better your tax result from these breaks. When the CBO took a closer look at that top 20 percent, or quintile, of taxpayers, it found that the to 1 percent of individuals benefit from tax expenditure more than any of the other four-fifths (or four quintiles) of the country's taxpayers.

The table below from the report displays this disparity.

It's no surprise that the preferential treatment of capital gains and dividends is a major factor in the uneven benefits distribution. As the tax returns of the uber-wealthy Warren Buffett and Mitt Romney showed us, rich folks tend to make money off their money rather than from wages like most of us in the lower quintiles.

The CBO estimates that in 2013 more than 90 percent of the benefits of reduced tax rates on capital gains and dividends will go to households in the top 20 percent of earners, with almost 70 percent going to households in the top percentile.  Those benefits will equal 2 percent of after-tax income for the highest quintile and 5 percent of after-tax income for households in the top percentile.

At the other end of the income scale, the CBO says that about half of the benefits of the EITC will go to households in the lowest income quintile. In this case, the benefits will equal 6 percent of after-tax income for households in that group.

The CBO report is of particular note because of its timing. Congress will be looking at tax matters this year as it deals with the debt ceiling and, possibly, broader tax reform. It's also worth noting that the CBO analysis was requested by Rep. Chris Van Hollen (D-Md.), the ranking member on the House Budget Committee.

Effects, intended or otherwise, of tax breaks: But regardless of who in which party sought the information, the findings of the CBO raise important questions about current tax policy.

Tax law often is designed to further societal goals. Tax breaks connected to health insurance costs, pension contributions and mortgage interest payments may help to promote a healthier population, sufficient retirement savings and stable neighborhoods.

But even the best-laid plans of lawmakers can go askew.

Tax breaks may, says the CBO, lead to an inefficient allocation of economic resources by encouraging more consumption of goods and services that receive preferential treatment.

They also may subsidize activities that would have taken place without the tax incentives. A prime example if homeownership, which does quite nicely in most of the rest of the world without the mortgage interest deduction.

And by providing benefits to specific activities, entities, or groups of people, tax expenditures increase the size and scope of federal involvement in the economy.

You can bet these and other consequences of the many, many tax breaks we now enjoy -- some more than others -- will be discussed on and off Capitol Hill.

I did just that last week at my other tax blog.

In my item on how the rich benefit the most from tax breaks, I cited another take on tax expenditures, the Joint Committee on Taxation regular look at what these uncollected tax amounts cost the U.S. Treasury.

Also last week at Bankrate Taxes Blog I reminded generous readers of the IRS' charitable giving rules if they're considering making donations to tornado victims.

You can find my other tax blog thoughts on most Tuesdays and Thursdays. If you happen to miss my posts over at Bankrate during the week, you can find a summary (and links) here the following weekend.

You also might find these items of interest:

• Comparing federal tax expenditures
• High-income filers avoiding tax, too
• Popular, and costly, tax breaks that could be trimmed to help reduce the deficit