Why do we spend so much Federal tax money on the rich in the US?

Why do we spend so much money subsidizing the highest earners (which includes me and most of you reading) in the US tax code?

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Above from: https://www.cbpp.org/research/federal-tax/policy-basics-federal-tax-expenditures

58% of ‘tax expenditures’ go to the top 20% of households by income. 24% go to the top 1% alone! Tax expenditures cost $1.4 T per year, which is more than medicare, social security, and defense spending (individually, not combined.) These expenditures are commonly referred to as tax breaks, but they function just like spending. You can think of them as tax money the government collect, but then immediately turns around and gives out to anyone meeting certain criteria, which is exactly how ‘entitlements’ like social security & medicare work. Interestingly, these benefits for the wealthy, if eliminated, would completely balance the budget by erasing our annual deficit (the difference between what the Federal government takes in from tax revenues minus the money it spends.)

Screen Shot 2020-04-29 at 12.40.29 PM Source: https://www.cbo.gov/topics/budget

The mortgage interest deduction, 401k contributions, and all the tax-free benefits we get through employers like our health insurance, transit, and dependent care disproportionately benefit those in the top of the income distribution. Despite this, when people talk about ‘government spending’ they tend to take aim at the relatively small amount spent on poor people like housing subsidies, food stamps, and welfare.

(In case you’re curious, the Trump tax cuts didn’t alter the amount of tax expenditures by much. That said, they benefitted the rich much more than the less-rich, both in dollar and, more egregiously, on a percentage of income basis.)

Health insurance benefits are a huge one, which is insane, because we already spend about 17% of our annual GDP on health care, so why would we want to incentivize ourselves to spend even more on it, which is a huge windfall to all the insurers and hospitals making money from the system! Tax expenditures are meant to encourage certain types of consumption behavior (spend money on your retirement vs now, spend money on health care vs food/fitness, spend money on mortgage debt vs paying cash for your house). Sometimes these incentives might make sense. I personally would favor an ‘above the line’ (no need to itemize) deduction for charitable donations because I think it’s good encourage people to give their money away to others that can better use it.

There’s no reason for the government to let me write off nearly $20,000 of my income for maxing out my 401k account at work. I’m going to save that money anyway, as evidenced by the fact that when I max out my 401k, I continue to save any extra I can in a taxable account. Ditto for the mortgage interest deduction, which costs us $30 B per year and nearly all of which goes to people making more than $100,000 per year. There’s really only ONE tax expenditure which goes mostly to the poor, and that’s the Earned Income Tax Credit. Everything else is spent mostly on the wealthy, and the wealthier they are, the higher the dollar share of the credit they get for most expenditures.

Capping benefits at a low dollar figure, phasing them out based on income or wealth, or converting deductions to flat, refundable tax credits would help shift the benefits to those who really need them. The simplest thing to do would be to just eliminate most of these benefits, and perhaps replace the small amount of money that was going to the poor and lower-middle class with a few hundred dollar monthly universal income handout to everyone in the lower ~50% of the income distribution. (Charles Murray has suggested this, but with a much more comprehensive elimination of government entitlements, here.)

You can see a list of the top 10 tax expenditures here, or if you’re a policy nerd like me, read all the gritty details here.

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Above from: https://www.taxpolicycenter.org/briefing-book/what-are-largest-tax-expenditures

Author: Ward Williams

Personal finance blogger with an interest in saving, investing, and learning new skills and doing things for myself & others!

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