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1 How Specifications of the Reference Tax System Affect CBO's Estimates of Tax Expenditures 1 (December 15, 2021)

handle is hein.congrec/cbohsprta0001 and id is 1 raw text is: The Congressional Budget Act of 1974 (the Budget Act) defines tax expenditures as those revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which pro- vide a special credit, a preferential rate of tax, or a deferral of tax liability.' Tax expenditures thus arise from provi- sions (exclusions, deductions, tax credits, and preferential rates) in the federal tax system that grant special tax treat- ment for certain types of income, activities, or groups. In turn, those provisions cause government revenues to be lower than they would be if the provisions did not exist. Tax expenditures have a large effect on the federal bud- get. On the basis of estimates prepared by the staff of the Joint Committee on Taxation (JCT), the Congressional Budget Office estimates that the value of all tax expendi- tures in the individual and corporate income tax systems totaled $1.6 trillion, or 7.8 percent of gross domestic product, in fiscal year 2019.2 That amount was equal to nearly half of all federal revenues, exceeded all discretion- ary outlays, and totaled about 60 percent of all man- datory spending in the federal budget, which includes spending on Social Security and Medicare. To identify and measure tax expenditures, the normal tax structure in which such provisions represent special treat- ment must first be defined. That normal tax structure is known as the reference tax system-the underlying framework of tax laws and administrative practices in which tax expen- ditures are analyzed. Thus, a reference tax system reflects a particular conceptual basis for taxation as well as other features necessary to implement and administer the tax code. This report outlines how the specifications of the refer- ence tax system used by CBO affect the agency's esti- mates of tax expenditures. Before the Budget Act became law, both the Treasury and JCT produced estimates of tax expenditures. Although the Budget Act subsequently required CBO to report on tax expenditures, it did not establish a specific framework for identifying or mea- suring them. As a result, there is no single, consistent definition of the reference tax system or its features that is universally used when analyzing tax expenditures. The specifications of such a system can therefore vary, which has led analysts to disagree about the appropriate spec- ifications for the reference tax system and the resulting estimates of tax expenditures.3 Determining the Conceptual Basis of the Reference Tax System: Income Versus Consumption Conceptually, a reference tax system can be based on either an income tax or a consumption tax.4 Although the Treasury and JCT have used an income tax as the basis for the reference tax system in their analyses, the U.S. tax system has features of both an income tax and a consumption tax.5 In theory, the two constructs are closely related because comprehensive income can be defined as consumption plus the change in net worth. In practice, the specifications of a consumption tax can vary, and such a tax can be administered in more than one way.6 Although a value-added tax applied at the point of sale is perhaps the most commonly recognized type of consumption tax, modifying the existing income tax to exempt the return on saving and investment would, in effect, be economically similar to basing a reference tax system on a consumption tax.7 As with an income tax, the particular specifications of a consumption tax have implications for what is considered normal in the tax structure, what is considered special treatment, and thus which provisions qualify as tax expenditures. Does the taxable base comprise all consumption, for example, or are some items, such as spending on services provided by government, excluded in the reference tax system?

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