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Lost Revenues?
Faced with ever-rising demands
for new spending programs, Con
gress is anxiously searching for new
ways to pay for such programs. In
particular, it is now closely examin
ing "tax expenditures” —at the
House Ways and Means Commit
tee's current hearings, and at
other committee sessions as well.
Tax expenditures are revenues that
the Treasury fails to receive
because of special treatment
granted to individual or corporate
taxpayers. Specifically, they are
defined as revenue losses attribut
able to a special exclusion, ex
emption or deduction from gross
income, or attributable to a
special credit, preferential tax rate
or deferral of tax liability. Total
"losses” of this type approximated
$75 billion in fiscal 1974 and $81
billion in fiscal 1975, according to
a table published (for the first time)
in the current budget document.
This new emphasis on tax expendi
tures reflects the pressure of tax
reformers who believe that the
entire tax system should justify itself
in the same way the appropria
tions system does.
Critics and defenders
Each type of preference has its
critics and defenders. For example,
should we continue to subsidize
farmers to the tune of almost $1.0
billion a year because of specific
tax provisions applicable only to
farm income? Again, should we
continue to subsidize home
owners to the tune of $10.3 billion
a year because of the tax deducti
bility of mortgage interest and1
1
Digitized for FRA SER
property taxes—a feature not
available to renters? Or should
we continue to subsidize small
business with at least $3.5 billion in
preferences because of the re
duced tax rates applicable to the first
$50,000 of corporate income?
Defenders of the present system
claim that it should be retained
because of its many benefits for
ordinary taxpayers, put into law by
Congressional decisions to support
certain worthwhile activities.
(Individuals account for about
three-fourths of all such tax
benefits, and corporations account
for the rest.) In their view, the taxreform tactic can be pushed to
excess, because it would imply that
all income covered by tax legisla
tion rightfully belongs to the
government, and that whatever
the government decides not to
collect (through exemptions)
constitutes a suspect subsidy.
Tax reformers, in contrast, claim
that a proper income-tax structure
should include in the tax base all
sources of income, allowing deduc
tions for expenses incurred in
obtaining that income. They add,
however, that any special provision
beyond that point is a subsidy
which merits full Congressional
scrutiny. Reformers admit that
some tax expenditures largely
benefit low-income taxpayers; for
example, through the tax exemp
tion of unemployment compensa
tion, workmen's compensation
and public-assistance payments.
But they argue that the greatest
benefits go to higher-income
(continued on page 2)
Federal
Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.
groups. In 1972, the average
individual in the $3-5,000 tax
bracket received $10 in taxexpenditure benefits, but aver
age benefits rose to $1,358 in the
$25-50,000 bracket and to $29,264
in the $100-500,000 bracket.
The estimates of total revenue
"losses" prepared by the Office of
Management and Budget are
somewhat inexact, especially since
they fail to take into account the
interactions among different pref
erence categories. OMB assumes
that the tax structure, average
taxpayer behavior and the general
economic situation all remain
unchanged in response to the
hypothetical deletion of individ
ual tax-expenditure categories.
Such assumptions in many cases
are unrealistic; for example, the
deletion of the investment-tax
credit presumably would harm the
economy, and this in turn would
affect other preference categories
such as unemployment-insurance
benefits.
Moreover, OMB deletes from its
list certain preferences that it
argues are normal features of the
tax structure, such as rapid depre
ciation write-offs, failure to tax
capital gains at death, and defer
ments of tax payments on foreignsource income—preferences
which some critics claim should be
included in its list. Again, the
figures are inexact because only
preliminary estimates are now
available regarding the impact on
tax preferences of the Tax Reduc
tion Act of 1975.
2
Digitized for FRA SER
How much involved?
Given these qualifications, tax
expenditures as a group were
estimated at $81.4 billion for fiscal
1975. The OMB study broke the total
into 15 major categories, but
three of those categories account
ed for 46 percent of the total
amount involved. Income-security
activities brought about a $16.1
billion revenue loss, since such
income benefits as social-security,
pension and unemploymentinsurance payments are all ex
cluded from taxable income.
Another $16.0 billion was involved
in tax-investment preferences
available to holders of both real
and financial assets; most of this
came from the homeowner's
ability to deduct from gross in
come both the mortgage interest
and the property taxes on owneroccupied homes, although the
favorable tax treatment of capital
gains also fell under this heading.
Another $5.7 billion came from a
third (health) category, reflecting
the individual's ability to deduct
medical expenses from gross in
come, and to exclude employer
contributions to medicalinsurance premiums from taxable
income.
Two other categories, related
mainly to Federal fiscal assistance
to other levels of government and
to nonprofit institutions, accounted
for 26 percent of the overall
revenue loss. These included the tax
deductions for state-local taxes,
charitable contributions and
consumer-credit interest, as well
as the nontaxable status of statelocal government debt. Three
other categories, related to busi
ness investment and resources
development, accounted for 20
percent more of the total. These
included the investment tax
credit, the corporate surtax exemp
tion below $25,000 income, and
the special provisions for firms
involved in the extraction of natural
resources. The other seven cate
gories were relatively minor in
dollar terms, although they in
volved such popular programs as
the tax exclusion of veterans'
benefits, the special treatment of
farmers' capital outlays, and the
deductibility of child-care and
dependent-care expenditures.
The Tax Reduction Act has affected
tax expenditures in both direc
tions, although no official estimate
has yet been made of its overall
impact. For individuals, the Act
tends to reduce estimated tax
expenditures because of the
increase in the minimum standard
deduction. But in the other direc
tion, the Act increases certain
preference items, especially
through the tax credit of 10
percent of earned income for lowincome wage earners, but also
through the new-home purchase
credit and the widening of eligi
bility for child-care deductions.
For corporations, certain prefer
ences are tightened—the elimi
nation or reduction of the oildepletion allowance and the
Digitized for FRA SER
change in treatment of foreignearned profits—but these are
more than offset by the revenue
loss caused by the increase in the
investment tax credit and the
reduction in tax rates on the first
$50,000 of profits.
What objectives?
In the main, tax expenditures are
designed to achieve specific econ
omic and social objectives
through fiscal activities. Thus, they
can be viewed as alternatives to
other fiscal tools such as credit
programs and direct outlays. Most
such preferences either encourage
certain activities—for example, the
broadening of home-ownership,
the operation of small businesses,
or the financing of state-local
governments—or they reduce the
burden of those in adverse cir
cumstances such as the blind, the
aged, and low-income
individuals.
As in other areas, however, our
economic and social objectives
change over time, and thus ne
cessitate a review of our tax laws.
The Ways and Means Committee, in
its current deliberations, may
tighten up on some tax expendi
tures while loosening others in
an attempt to meet new national
goals. But increased Congression
al scrutiny of these preferences is
clearly in the works. In fact, the
Budget Reform Act of 1974 spe
cifically enjoins the new budget
committees to “ devise methods
of coordinating tax expenditures,
policies and programs with direct
budget outlays."
Rose McElhattan
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BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
6/25/75
Change
from
6/18/75
Loans (gross, adjusted) and investments*
Loans (gross, adjusted)—total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
O ther securities
Deposits (less cash items)—total*
Demand deposits (adjusted)
U.S. Governm ent deposits
Time deposits—total*
States and political subdivisions
Savings deposits
O ther time deposits!
Large negotiable CD's
85,168
64,244
1,022
23,294
19,585
9,835
8,474
12,450
85,329
23,147
445
60,341
6,904
20,276
29,399
16,045
Weekly Averages
of Daily Figures
W eek ended
6/25/75
Member Bank Reserve Position
Excess Reserves
Borrowings
Net free (+) / Net borrowed (-)
Federal Funds—Seven Large Banks
Interbank Federal fund transactions
Net purchases (+) / Net sales (-)
Transactions of U.S. security dealers
Net loans (+) / Net borrowings (-)
+
-
-
+
+
-
+
-
+
-
+
+
+
53
0
53
945
402
411
99
7
22
614
71
591
400
637
499
69
69
321
336
Change from
year ago
Dollar
Percent
W eek ended
6/18/75
+
+ 1.59
2.24
- 17.91
0.91
+ 0.60
+ 4.53
+ 66.61
4.49
+ 7.69
+ 6.05
57.21
+ 9.84
+ 3.43
+ 12.86
+ 7.00
+ 13.09
+ 1,329
1,474
223
214
+
116
+
426
+ 3,388
585
+ 6,096
+ 1,320
595
+ 5,408
+
229
+ 2,311
+ 1,923
+ 1,857
Comparable
year-ago period
66
0
66
-
6
141
147
+ 1,475.8
+ 2,374.5
+ 1,606.7
+
+
+
490.3
940.7
495.9
♦Includes items not shown separately. {Individuals, partnerships and corporations.
Information on this and other publications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 397-1137.
Digitized for FRA SER
http://fraser.stlouisfed.org/
Federal Reserve Bank of St. Louis
E>jSE|V
@FedFRASER