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New York University School of Law

Public Law and Legal Theory Research Paper Series

Research Paper No. 72

New York University

Center for Law and Business Working Paper Series
Working Paper No. CLB 03-20

Rethinking Tax Expenditures and Fiscal Language

Daniel N. Shaviro

September 2003

This paper can be downloaded without charge from the

Social Science Research Network Electronic Paper Collection at:

Daniel N. Shaviro*

Preliminary Draft

All Rights Reserved


Tax expenditure analysis is like a hardy plant with shallow roots that spreads

widely, resisting the occasional effort to extirpate it, and yet has little if any effect on the

soils in which it sprouts. At least sixteen countries release tax expenditure data,

pertaining not just to income taxes but also to sales, value-added, payroll, inheritance,

excise, property, motor vehicle, and betting-and-lottery taxes.1 However, the aim of

original American proponent Stanley S. Surrey, that tax expenditures once identified be

mostly converted into direct expenditures or repealed altogether,2 has made little if any

headway.3 This reflects not just political support for particular provisions and their

character as tax rules, but broader rejection of key tenets of tax expenditure analysis.4

Professor of Law, NYU Law School.
Organization for Economic Co-operation and Development, TAX EXPENDITURES:
RECENT EXPERIENCES 7, 65 (1996) (henceforth, “OECD Report”). The countries
included in this list are Australia, Austria, Belgium, Canada, Finland, France, Germany,
Ireland, Italy, Japan, Luxembourg, the Netherlands, Portugal, Spain, the United
Kingdom, and the United States.
Stanley S. Surrey, PATHWAYS TO TAX REFORM 179-180 (1973). Tax expenditure
analysis apparently sprung up more than a decade earlier in Germany, without the same
normative underpinnings and apparently without being noticed in the United States. See
Harry A. Shannon, The Tax Expenditure Concept in the United States and Germany: A
Comparison, 33 Tax Notes 201 (1986).
See Victor Thuronyi, Tax Expenditures: A Reassessment, 1988 Duke L.J. 1155, 1170-
See id. at 1178; Bruce Bartlett, The End of Tax Expenditures As We Know Them?, 92
Tax Notes 413, 419 (2001).

Such rejection, while encouraged by canards,5 reflects as well powerful criticisms of the

analysis that emerged almost immediately in the American academic literature6 and have

persisted since.7

To complain that tax expenditure analysis has not been politically more effective,

in the precise way that Surrey envisioned, might be asking not just too much but the

wrong thing. Even if one accepts his normative goals, one may rightly ask to what extent

a mere fiscal language innovation either can or should categorically shape political

outcomes. Perhaps more disappointing, therefore, is the repetitive and misdirected

conversation that the concept has generated in the tax policy community, too narrowly

focused on the defensibility of using of a canonical “reference tax base” in identifying tax


This article aims to put the tax expenditure concept on a more fundamental

footing, grounded in a fuller appreciation of fiscal language issues generally. Among its

main conclusions are the following:

1) The basic claim of tax expenditure analysis, that certain tax rules are “really”

spending, is not quite correct, because “taxes” and “spending” are not coherent categories

to begin with. However, the underlying idea can be restated in terms of Richard

Musgrave’s famous distinction between the allocative and distributional branches of the

I have in mind here the claim that tax expenditure analysis reflects the “sinister premise
…. [that one should] think of all income as virtual state property, and forbearance to tax
away every last penny of it as itself a tax expenditure.” Charles Fried, “Whose Money Is
It?,” Washington Post, January 1, 1995, page C-7. I discuss this view of tax expenditure
analysis infra at __.
See Boris I. Bittker, Accounting for Federal “Tax Subsidies” in the National Budget, 22
Nat’l Tax J. 244 (1969).
See, e.g., Douglas A. Kahn and Jeffrey S. Lehman, Tax Expenditure Budgets: A Critical
Review, 54 Tax Notes 1661 (1992).

fiscal system.8 Allocation involves affecting the amount, use, and character of all assets

in our society, while distribution involves affecting who has what. Thus, paying police

and building roads are allocative activities, while using income measures to determine tax

liabilities or transfer receipts is distributional. Tax expenditures (a term worth preserving

for its familiarity) are best defined as allocative rules that, as a formal matter, are found

within the (ostensibly distributional) tax system.

2) The allocative or distributional character of a given rule is a matter both of

degree and, in some cases more than others, of reasonably contested opinion. Tax

expenditure analysis ought to be more flexible and varied in its groupings than in the

Surrey tradition, where each rule is canonically classified as tax expenditure or not

relative to a specified reference tax base that itself reflects both contestable distributional

judgments and a set of administrative compromises. In addition, estimates should be

made for tax penalties or negative tax expenditures, arising in cases where a tax rule is (at

least arguably) harsher than a purely distributional policy might be thought to suggest.

3) One key reason for the value of tax expenditure analysis as an exercise, even in

the flawed manner in which it is currently done, is that it addresses the confusion in

public policy debate that may occur when proponents of placing particular allocative

rules in the tax system exploit the common tendency to define “taxes” and “spending”

entirely formally, and yet to treat the categories as genuinely meaningful. When an

allocative program uses tax benefits, such as special deductions or credits, in lieu of

direct appropriations, “taxes” and “spending” for the fiscal system as a whole may appear

to be lower, even if the choice of mechanism has no effect on the substance of

See Richard Musgrave, THE THEORY OF PUBLIC FINANCE v (1959).

government programs. Unfortunately, Surrey, in promoting his version of tax

expenditure analysis, undermined this clarifying function by also enlisting the analysis as

a weapon in battles concerning what the government’s distribution policy should look

like – in particular, his support for progressivity and comprehensive income taxation.

Even those who share his distributional views ought to recognize by now that tax

expenditure analysis cannot be politically effective – even leaving aside the intellectual

defensibility of the enterprise – when it is fighting so many battles at once.

The discussion proceeds as follows. Section II discusses the broader fiscal

language issues that underlie classifying particular government rules as taxes or spending.

Section III discusses how tax expenditures could be and have been defined. Section IV

addresses the important (but little-noticed) discussion of tax expenditure analysis by the

U.S. Treasury Department that was included in the official Budget of the United States

Government for 2003 (henceforth, the “Treasury Discussion”),9 and offers suggestions

for the future use of tax expenditure analysis. Section V offers a brief conclusion.

See Analytical Perspectives, Budget of the United States Government for Fiscal Year
2003, pages 95-127.


A. The Dual Character of Fiscal Language as a Descriptive Tool and a

Political Weapon

The government, through its agents’ actions and the rules it imposes, does a great

many things. When it deals in cash or in near-cash (such as reimbursements or

vouchers), we may describe it as operating a fiscal system. The fiscal character of its

actions is a matter of degree, and can be emphasized or not as one likes. Thus, as I have

discussed elsewhere, one might think of minimum wage laws either as workplace

regulation, involving the organization of a mandatory cartel among low-wage workers, or

as equivalent to an off-budget tax on the employers of such workers accompanied by an

off-budget transfer to those same workers.10 The rationale for distinguishing between the

fiscal system and everything else the government does is simply ease of measurement.

For example, one can more easily place a dollar value on an individual’s retirement

pension, or even the subsidized healthcare services that she receives, than on her benefit

from public goods such as national defense spending.

Even once one has determined which rules to treat, for a given purpose, as within

the fiscal system, one needs further organizing terminology. Otherwise, one simply has a

welter of rules with no clear organizing principle to help in thinking about them. Among

the more prominent fiscal language terms in current or recent American usage are taxes,

spending, fines, user fees, budget deficits or surpluses, trust funds for programs such as

Social Security, and lockboxes. These are not Platonic categories, but rather clusters of

ideas, often with associated connotations. Thus, consider taxes and spending. The

See Daniel Shaviro, The Minimum Wage, the Earned Income Tax Credit, and Optimal
Subsidy Policy, 64 U. Chi. L. Rev. 405 (1997).

former might be defined as payments to the government and the latter as payments from

the government, with additional refinements to distinguish them from the likes of

contract payments, fines, and user fees. This does not, however, exhaust their widely

accepted meaning. At least in American usage, there is a bit more baggage to consider.

“Big government,” a term of opprobrium, is characterized or even implicitly defined as

involving high taxes and spending. All else equal, therefore, political actors will want to

categorize their opponents’ proposals as involving high taxes and spending, and their

own proposals as involving low taxes and spending, even if the only real difference in

substance is who benefits.

Connotation is so pervasive that fiscal language has a dual character. It is both a

purportedly objective descriptive tool and a weapon of political combat. However, its

use as a political weapon is parasitic on its claim to offer objective description. For

example, if calling a proposed rule a tax is recognized as merely a matter of convention,

rather than reflecting something significant about the rule’s substance, then any inference

we are being invited to draw from the label, such as that it is an example of “big

government,” is unlikely to persuade. Classifications must seem meaningful if broader

inferences are to be associated with them.

Unfortunately, the characteristics that underlie our fiscal language categories are

often purely formal, rather than meaningful. Consider the distinction between taxes and

spending, based on whether cash is traveling to the government or from it. Anyone who

ever shops or has a job, is likely to make some payments to the government. Indeed,

nearly everyone ends up making net lifetime payments to the government, even if she

gets good value in her overall dealings, since the receipt of public goods is excluded from

the calculus. Against this background, it makes no economic difference whether, at any

given moment, one gets a dollar back (“spending”) or is allowed to pay a dollar less

(“taxation”). A dollar is a dollar.

The distinction between taxes and spending thus depends on pure form. For

example, “ spending increases” can be converted into “tax cuts” if they are netted against

tax payments before made in a manner that looks sufficiently as if the tax system is the

responsible agent. And we seemingly can have “smaller government” in lieu of “bigger

government,” even without any policy change, simply by netting things out so that the

observable gross cash flows in each direction are smaller.

What ought we really to mean by “big government”? Or, leaving aside any

implications that it is good or bad, what should interest us, from a consequential

standpoint, about a given government program? Presumably, what we really care about

is its effects on allocation or distribution – that is, on what we have as a society and who

among us has it. A bigger government, therefore, is one with greater rather than lesser

effects relative to the baseline that is used in making this assessment.

Our fiscal language would actually be dealing in substance if it thus described the

allocative and distributional effects of government programs. To be sure, identifying the

counter-factual state baseline might pose quandaries. (No government? But also no

Hobbesian state of nature? Current policy as the baseline for the effects of proposed

changes?)11 Yet even if this left some scope for political warfare over fiscal language –

since baselines may look normative even if chosen just for convenience – at least the

description of effects relative to the baseline would be meaningful.

For further discussion of these issues, see Daniel N. Shaviro, The Bush II Tax Cuts:
Steps Towards Bigger Government?

Unfortunately, the creation of comprehensive allocative and distributional

measures of the effects of government policies is complicated conceptually,12 and would

in practice involve considerable empirical difficulty. After all, the distributional

incidence and allocative effects of various programs are scarcely matters of consensus.

The use of cruder and more formal measures is therefore unsurprising – although more

ought to be done in developing the substantive measures, and although the ones we now

use could be improved as well as used more thoughtfully.

Tax expenditure analysis is a response to the inadequacy of “taxes” and

“spending” in common usage. Before focusing on it directly, however, I offer four

examples of the problems with common usage of “taxes’ and “spending” – all drawn

from the United States due to my greater familiarity with its fiscal system, but (I hope)

having broader application. The theme that should emerge from them is that prevailing

fiscal language is too manipulable in some respects yet too rigid in others. The first and

last examples show how it can be manipulated, subject to rules of the game that are

arbitrary even if at times effective. The middle two are more sinister, because they show

how fiscal language can mislead even sincere advocates of a given policy or, through its

rigidity, rule out what might be reasonable policy options on bogus grounds.

For an initial effort at describing how the allocative and distributional measures might
be constructed, see David Bradford, Reforming Budgetary Language, CESifo Working
Paper No. 619 (December 2001).

B. Taxes Versus Spending or Both Versus Neither: Some Examples

1. United States Income Taxation of Social Security Retirement


In 1993, President Clinton sought to reduce the federal budget deficit through a

package that combined spending cuts with tax increases. Mindful of years of Republican

attacks on Democrats’ claimed proclivity to “tax and spend,” his Administration started

out by promising a 3-1 ratio of spending cuts to tax increases. However, this gradually

dropped to 2-1 and finally to 1-1.

As an aside, the fact that the ratio dropped, notwithstanding the evident political

advantages of “cutting spending,” shows that the relevant fiscal language was not

completely manipulable. President Clinton wanted to retain various allocative programs

that furnished particular goods and services, while changing distribution so that high-

income individuals would bear a greater burden. The former programs were mainly

classified as spending, while the latter aim in large part had to be done through the tax

system. So in practice the spending and tax measures were not wholly unrelated to

meaningful measures of the government’s allocative and distributional effects.

As David Bradford relates:

[C]ritics redid the numbers in many ways …. [and] the Senate Budget
Committee minority (Republican) staff concluded that the version of the
Clinton program that passed the House incorporated $6.35 in taxes for each
$1 in spending cuts. The argument involved in part matters of defining
baselines and of netting …. [One big dispute, however, concerned] the
Clinton Administration’s proposal to increase the portion of Social Security
retirement benefits that are subject to income taxation (a proposal that was
subsequently enacted). The Administration described this proposal as a

reduction in spending of $21.4 billion over five years. It did not count the
change in its table of “revenue provisions,” where tax changes are
customarily summarized. Critics cried foul and they found support in the
analysis by the even-handed Congressional Budget Office that placed the
provision in the category of “revenue proposals.”13

Was President Clinton’s classification wrong? The Congressional Budget Office

was not alone in thinking that it was. He also captured third place in the 1993

Doublespeak Award, administered by the National Council of Teachers of English, for

this maneuver plus his insistence on “using the word ‘investment’ as a substitute for the

word ‘spending’ in his rhetoric on economic policy.”14 Apparently, however, the Reagan

Administration had gotten away with classifying income taxation of Social Security

benefits as a benefit cut15 - naturally, without protest from Clinton’s subsequent critics.

The Clinton Administration argued that its proposal really was a spending cut

because its effect was to reduce seniors’ net Social Security retirement benefits. It was

“wrong,” apparently, because the Social Security checks that seniors got in the mail

would not be affected. Instead, the change affected their computations of taxable income

and thus the income tax payments they sent to the federal government. So apparently it

“really” was a tax increase within the accepted conventions.

Suppose, however, that there had been a politically acceptable way to give the

Social Security Administration information from seniors’ tax returns that it could use to

reduce all benefit checks by exactly the amount of the tax increase under the actual

Id. a 4-6.
Jan Ackerman, Forked Tongues Prevail on High; Pentagon Gets Annual Doublespeak
Award from Teachers Group, Pittsburgh Post-Gazette, November 22, 1993, page B-1.
Steven Greenhouse, Clinton’s Economic Plan: Seeing Figures, 2 Sides Calculate
Clinton’s Math, New York Times, February 22, 1993, page A-14.

proposal and enactment. Then, despite identical economic effects, this presumably would

have been accepted as a spending change rather than a tax change. Under this scenario,

however, a brand-new concern might have arisen. The United States would have been

means-testing Social Security benefits – a gross violation, in some people’s view, of the

sacred social compact under which Social Security is a universal program, and yet

evidently not a concern under the actual (and substantively identical) 1993 enactment.

2. Enormous Tax Cuts in the Face of an Enormous Fiscal Gap

In his proposed federal budget for 2003, President Bush proposed tax cuts that the

Congressional Budget Office estimated would cost $1.5 trillion over ten years despite

being backloaded through gradual phase-in.16 Congress then passed tax cuts that were

expected to cost $318 billion over ten years, although the reduction largely reflected

sleazy accounting tricks such as “sunsetting” new provisions that the proponents actually

planned and expected to retain. The tax cuts were enacted notwithstanding enormous

budget deficits, expected to grow indefinitely, and widely recognized as endangering

seniors’ Social Security and Medicare entitlements.17

Cutting taxes at a time when United States fiscal policy already fell so far short of

being on a sustainable path raised questions of what (if anything) the Administration and

its Congressional allies had in mind for the long term. One widely bruited theory among

observers held that the unstated underlying goal must be to “starve the beast,” i.e., reduce

the government’s resources so severely that enormous spending cuts, at present

[Cite CBO]
Estimates of the long-term fiscal gap, or the present value of the excess of expected
spending over expected taxes under a reasonable projection of current policy, ranged
from $44 trillion to $74 trillion. [Cite Gokhale & Smetters; Shaviro in World Econ. J.]

politically unfeasible, would be inevitable down the road.18 Given existing budget

priorities, this scenario would have to involve enormous future cuts in Social Security

and Medicare benefits. Reducing outlays, say, on highways, farm subsidies, and welfare

benefits would only be a drop in the bucket.

However deceptive one might find the Administration’s methodology under this

scenario (which offered the only way to make sense of its long-term policy), it could at

least be defended as reflecting sincerely held underlying principles. Restraining

Leviathan is a central theme in conservative American politics, reflecting faith in

markets, distrust of politics, and aversion to progressive redistribution. Was the

Administration correct, however, in thinking (if it did) that the government really would

be smaller over time if taxes were cut now and entitlements cut (even more than would

otherwise have been necessary) later?

This is far from clear. The belief that it is clear may rest on spending illusion, or

confusing the size of the nominal dollar flows between individuals and the government

with the actual size of government. Again, we should think of the size of government in

terms of its allocative and distributional effects relative to some state of affairs where it

was doing less. Reciprocal cash flows, however, such as the case where you and the

government give each other a dollar, do not involve such effects. Social Security and

Medicare have enough in common with mere dollar swaps that even the allocative and

distributional effects which they concededly have do not come anywhere near to being

measured accurately by their nominal cash flows.

If so, however, then it was curious that the Administration also was proposing spending
increases estimated at $750 billion over ten years, including a costly expansion of
Medicare to include a new prescription drug benefit. [Cite CBO].

Suppose we start by imagining a government-run, mandatory pension program

that is actuarially fair, in that people’s retirement benefits equal the value of their

contributions. By definition, such a program is non-redistributive. It will also have zero

allocative effects if people are far-sighted and can borrow and lend at the interest rate

used to equate contributions and benefits. Such a program would therefore have no

effects whatsoever, despite its involving billions of dollars of observed “taxes” and

“spending” each year.

Needless to say, actual government-run retirement programs, such as Social

Security in the United States, are not nearly so vacuous. They may involve vast

redistribution – in practice, chiefly from younger to older age cohorts. In addition, they

result in forced retirement saving or consumption smoothing,19 since participants cannot

easily dissave in advance the accruing value of their retirement benefits. They therefore,

even if non-redistributive, affect work incentives and lifetime consumption patterns.

Even so, however, these effects are not well-measured by the observed cash flows from

the programs’ taxes and spending.20 Surely the government would be much bigger, in

real terms, if more of the gross amounts were being redistributed and if the outlays took

the form of specific government-produced goods and services that the benefiting seniors

would not have chosen if offered the cash.

Against this background, how should we think of the size-of-government effects

of the Bush Administration policy of enacting enormous tax cuts in 2003, significantly to

The case of Medicare is slightly more complicated, because seniors are required to
consume the retirement benefits in the form of healthcare. It is likely, however, that the
benefits are worth a high percentage of their cash cost to the recipients, reflecting the
relative low compensated elasticity of healthcare expenditure. Cite WHO SHOULD PAY

the benefit of the wealthier (and thus generally older) members of current generations,

and to be made up down the road through reductions in Social Security and Medicare

benefits? In answering this question, one should keep in mind that current seniors have

done much better under these programs on a lifetime basis than younger generations were

expected to do even before the 2003 tax cuts. Largely for this reason, lifetime net tax

rates (lifetime taxes paid minus transfers received, divided by lifetime income) are

expected to be much lower for current and older generations than for future and younger

generations.21 In consequence, the 2003 tax cuts arguably made the government bigger.

They lowered one already-low set of lifetime net tax rates in exchange for raising another

already-high set of such rates. They thereby may have increased total redistribution

through the U.S. fiscal system (just as defaulting on government bonds might have this

effect). The 2003 tax cuts also may have increased the total distortionary effects of the

fiscal system, by likely requiring higher marginal tax rates in the future, thus violating the

principle of “tax smoothing” under which rates should remain relatively constant in order

to minimize tax-induced changes in the timing of economic behavior.22

Accordingly, if we credit the Bush Administration with sincere long-term

ideological goals (rather than just short-term political goals) in its 2003 budget policy, it

may have been deceived by the fiscal language of nominal taxes and spending into doing

the opposite of what its presumed anti-government ideology might dictate. Yet the news

gets worse still. If there is any good reason at all to favor current over future generations,

it is that the latter may end up, for technological reasons, being wealthier (transfers

Cite generational accounting estimates.
See Robert J. Barro, On the Determination of the Public Debt, 87 J. Pol. Econ. 940
(1979). Note also the point about distortion rising with the square of the rate.

through the fiscal system aside) than we are.23 So the Bush Administration, contrary to

everything we know about its distributional preferences, appears to be following a

generational policy of massive progressive redistribution.

3. Means-Tested Welfare Benefits Versus Demogrants

People on the cusp of escaping poverty, such as by shifting from part-time to full-

time work, often face astonishingly high effective marginal tax rates. Several years ago, I

estimated that an American single earner with two dependent children who lived in a

state with relatively generous welfare benefits would potentially be better-off earning

$10,000 per year than $25,000 per year.24 The benefit of earning an extra $15,000 per

year before taxes would be more than offset by the combination of various positive tax

liabilities with phase-outs of such means-tested transfer programs as Temporary Aid to

Needy Families, Food Stamps, the earned income tax credit, Medicaid, and rent subsidies

if they were available despite being rationed.25

In describing this scenario as involving a marginal tax rate in excess of 100

percent, I was concededly rejecting the distinction that fiscal language conventions draw

between taxes and spending. I was equating income-related spending phase-outs with

income-related taxes. The rationale I offered was that a dollar is a dollar: income-related

spending reductions have the same incentive and distributional effects at the margin as

income-related tax increases.26 For example, if earning a dollar leaves me only eighty-

five cents ahead of where I was previously, it should not matter whether this reflects a

Cite Do Deficits Matter. Note the contrary argument from Medicare that we may want
to transfer resources to richer people who can do more with a dollar due to technological
Cite my Tax Notes piece on MTRs.
Note Kotlikoff on whether it pays to work.
Cite the MTR article.

fifteen-cent income tax liability or the loss of fifteen cents worth of cash-equivalent Food


The structural reason for imposing high marginal tax rates on people as they try to

escape poverty is straightforward. Welfare-type benefits are supposed to be limited to the

poor. Middle-income people, for example, are thought not to need them. If a benefit is

to be limited to the poor, then it must be phased out (or eliminated in a sudden “notch”)

somewhere within the range where one’s income, earnings, or assets become great

enough to indicate that one no longer is poor. Accordingly, despite the widely

recognized importance of encouraging people to escape poverty, the accepted line of

reasoning suggests that an economic penalty equivalent to that from imposing a high rate

of tax must be imposed on those who actually succeed in doing so.27

There was actually a relatively simple structural approach to easing this dilemma,

known to policymakers as the negative income tax or demogrant approach. Under this

approach – really just a change in fiscal language – basic welfare grants would be

nominally universal, but financed by an income-related levy, with the consequence that

they could match the desired generosity (be it high or low) of any conventional welfare

scheme without necessarily imposing high effective marginal tax rates on those escaping


The basic idea can be illustrated as follows. Suppose we think of $10,000 as the

poverty line, and $7,500 as the minimum amount that we can tolerate any member of the

“deserving” poor ending up with. (For present purposes, it does not matter how we

The dilemma can be avoided by simply not offering large benefits to the poor. The
time limits on welfare benefits that the United States imposed in connection with its 1996
welfare reform are an example of this approach. Cutting benefits is not generally the
right solution, however, if one actually wants to aid the poor.

define the deserving poor, so long as deservingness is defined other than in terms of

income.) Under a conventional welfare scheme, deserving people with zero income

might get a $7,500 grant, ratably phased down to zero as their incomes rose to $10,000.

Within this income range, therefore, under this approach we would have imposed a 75

percent effective marginal tax rate, disregarding any other taxes or means-related


In order to pay for this program, something else would have to be done. Suppose

we previously had an income tax with a zero bracket for up to $10,000 of income and a

flat 25 percent rate above that, and that we proposed to pay for the program solely by

raising the flat rate to 30 percent. We would now effectively have two marginal tax rates:

a 75 percent rate on up to $10,000 of income and a 30 percent rate above that.

Under the demogrant approach to describing the welfare system, all deserving

people as defined without respect to income – even Bill Gates if he otherwise qualified –

would nominally get the $7,500 demogrant. (It might, however, be netted against income

tax liabilities rather than literally being paid.) We still would have to pay for the

program, however. Suppose initially that we decided to impose a 75 percent marginal

income tax rate on up to $10,000 of income and a 30 percent rate on income above that.

We now would have a set of programs that was identical to those involving conventional

welfare. People’s net receipt or tax at all income levels would be exactly the same. This

choice seems politically unlikely, however, since most people believe that income tax

rates should be flat or graduated. Thus, adoption of the demogrant approach – or more

precisely, the demogrant description of the welfare system – seems likely to lead to a

different outcome, with lower marginal rates for the first $10,000 of income and thus

necessarily (all else equal, and assuming a current-year breakeven budget constraint) of

something more than 30 percent for income above $10,000.

Would the likely outcome of saying we have demogrants be better than the likely

outcome of saying we have a conventional welfare system? That depends on how one

evaluates the substantive policy issue of designing rate structures. Clearly, however,

marginal rate decisions would be more transparent under the demogrant approach.

Moreover, that approach would offer a wider range of choices if the conventional welfare

approach, in practice, virtually compels a given marginal rate structure once we have

determined (perhaps on very different grounds) the minimum transfer and maximum

income level at which some transfer should still be available.

As a political matter, however, adoption of the demogrant approach to describing

the welfare system would face severe obstacles, rooted in the conventional terminology

of “taxes” and “spending.” Objections to it might include the following:

(a) By giving demogrants to everyone, it is costlier than conventional welfare.

This, however, is a fallacy given that it is identical to conventional welfare if the

marginal tax rate on income of up to $10,000 is 75 percent.

(b) By giving demogrants to everyone (even Bill Gates if, income aside, he counts

as “deserving”), it gives money to people who do not need the aid because they are not

poor. But this is a fallacy for the same reason.

(c) It requires marginal tax rates to be higher than under conventional welfare.

But this is only true if we decide on a bottom-tier marginal rate of less than 75 percent.

Even in that case, marginal rates are merely different (higher in some ranges and lower

than others), rather than higher. Conventional welfare seems to have lower marginal

rates only because certain inputs to the rates are disguised.

In sum, adoption of the demogrant approach would itself be only a fiscal language

change, but one that (if it were considered persuasive) might plausibly encourage the

adoption of real policy change. Acceptance of it is impeded, however, by its tension with

prevailing fiscal language norms that people evidently do find persuasive. People might

resist assimilating the demogrant to the income tax in their thinking even if it was

presented as a refundable tax credit on income tax returns. The nub of the problem

would lie in the cases where people got a net payment, ineluctably converting the

demogrant into “spending” rather than a “tax” notwithstanding the economic principle

that a dollar is a dollar and that transfers, therefore, are merely negative taxes.28

4. The “Secret Bradford Plan” to Reduce the Deficit Through

“Spending Cuts”

In his above-cited discussion of new approaches to budgetary language, David

Bradford describes his pretended “secret plan” to eliminate a budget deficit by formally

cutting spending rather than taxes. In Step 1, all defense spending on weapons

procurement would be eliminated. In Step 2, a new “weapons supply tax credit” (WSTC)

would be enacted. “To qualify for the WSTC, manufacturers will sign appropriate

documents prescribed by the Secretary of Defense (looking much like today’s

procurement contracts) and deliver to appropriate depots weapons systems of prescribed

See, e.g., Musgrave, supra n. __, at 272.

characteristics. The WSTC, which may be transferred to other taxpayers without limit,

may only be used in payment of income tax. Step 2 is, apparently obviously, a tax cut.”29

Step 3 (changing the Bradford plan slightly) would be an income tax rate increase,

precisely making up the revenues that had been lost through enactment of the WSTC. In

form, therefore, tax revenues would be constant, while spending would have declined

steeply due to Step 1. As a result – putting President Clinton to shame – one could claim

that one had solely used spending cuts to accomplish deficit reduction, without raising

overall taxes at all. In substance, however, all that one would really have done is raise

income tax rates.

Bradford concedes that “the chances are pretty good some astute politician or

journalist would notice what is going on in this case.” If so, then “the policy process

would [have] see[n] through to the economic substance. But maybe not; permit me to

doubt.” 30 For what it is worth, my own take on this little story is that the WSTC, because

it is transferable, violates the accepted definition of a proper “tax” no less than it would

if, like the demogrant, it were made explicitly refundable to the extent in excess of the

weapons manufacturer’s income tax liability. As we learned in 1981 through 1982

through the failed political experiment of safe harbor leasing, at least in the United States

“tax” benefits cannot properly be sold to taxpayers with positive liability to offset, any

more than they can be refunded.31

The WSTC presumably needs to be refundable or transferable in order for the

proposal to work, because otherwise weapons manufacturers might not have sufficient

Bradford, supra n. __, at 8.
Bradford, supra n. __, at 8.
[Describe safe harbor leasing]

tax liability to use it in full. (Suppose, for example, that most of their income derives

from these very contracts.) Apart from this design problem, however, it is hard to see

why the Bradford plan could not work – at least, as to new weapons programs, so that its

enactment would not detectably involve outright program conversion.

Suppose that someone objected that no normative income tax would include a

WSTC, and that therefore it must be a “tax expenditure.” The following dialogue might

then ensue.

“How do you know this?” we might ask.

“Because no normative income tax base would include a WSTC.”

“But how do you know that?”

“Because I have consulted a number of experts, and not one of them would

include the WSTC in a normative income tax base.”

Now we could lower the boom, by quoting a recent criticism of tax expenditure

analysis by Douglas Kahn and Jeffrey Lehman. Does not this appeal to the experts

falsely “presume[] that some of us should be deemed to know the answers [to defining a

normative tax base] better than others?”32 Accordingly, Kahn and Lehman ask, how is

this any different from a hypothetical case in which someone tries to answer the question:

“Should the National Zoo house panda bears?” by stating his opinion and that of other

self-proclaimed experts that “normative zoos” should only house bears and that pandas

are not really bears?33

Two things about their critique should be obvious. The first is that they have a

point. How exactly do we identify the “normative income tax,” and why should we care

Kahn and Lehman, supra n. __, at 1665.

about it even if we could? The second is that their argument nonetheless misses

something important.34 In terms of the discussion above, while it cannot be quite right

that the WSTC is “really” spending if the distinction between “taxes” and “spending” is

vacuous to begin with, still, there is an evident distinction between offering the WSTC

and, say, allowing a shopkeeper to deduct from the income tax the salaries that he pays

his clerks. Where the tax expenditure debate went off the rails, reasonably drawing

Kahn’s and Lehman’s ire yet throwing them off-course as well, was not in its aim of

identifying “special” provisions such as the WSTC, but in its means of doing so, through

the identification of a supposedly canonical, yet in practice under-theorized and rightly

controversial, official definition of the “normative income tax base.”

Can we distinguish between the WSTC and ordinary business expense deductions

without becoming self-appointed zoo experts who are opining about panda bears? How

could we better expose the fiscal language scam that underlies the WSTC without

perpetrating our own fiscal language fallacies, and without courting all of the controversy

and lack of acceptance that has dogged tax expenditure analysis for the last thirty years?

Is tax expenditure analysis fatally flawed by its failing to use the more fundamental

language of allocative effects and distributional effects, or is there still a useful role that it

could play? I address these issues in the next section, after describing the origins of tax

expenditure analysis.

In fairness, they do describe their criticism of tax expenditure budgets as “pragmatic,
not nihilistic. We do not believe that all arguments are equally good, or equally
persuasive …. We find it valuable to point out [as tax expenditure analysts mean to do]
those provisions of the code that depart from what one would expect to find if one’s sole
concern were measuring” some measure, such as income, of relative wellbeing. Id.


A. Origins and Reception of Tax Expenditure Analysis

Tax expenditure analysis seems to have been invented twice. In Germany, as

early as 1954, writers had noticed the “equivalence between special tax deductions,

credits, and other allowances and government subsidies.”35 They apparently did not view

this as a criticism. Rather, “the German literature generally affirms that the tax system

furnishes a useful instrument for implementing economic and social policy and

acknowledges that it is often used for such ‘nonfiscal’ purposes.”36 By 1959, the German

government had begun reporting on subsidies in the federal budget, including those

supplied through the tax system, with an eye to improving budgetary control. The stated

motivation was that, if subsidies generally were to be reduced, these “invisible” and

indirect subsidies (measured by the foregone revenue) should be placed on a par with the

subsidies that were provided more overtly through direct spending.37 Budgetary reports

on tax subsidies that were classified as indirect spending were being made regularly by

1967, although it is unclear how widely this was noticed outside Germany.

The term “tax expenditure,” and accompanying German-style (but perhaps

independently invented) practice of estimating the revenue loss from “spending”

rules in the tax code, was introduced in the United States with considerably more fanfare

in 1967. On November 15 of that year, in a widely noticed speech to the Money

Marketeers, a New York financial group, Stanley S. Surrey, the Assistant Secretary of the

Treasury for Tax Policy, called for a “tax expenditure budget” that would report the

Shannon, supra n. __, at 203.
Id. at 204.
See id.

revenue cost of “deliberate departures from accepted concepts of net income … [through

which] our tax system does operate to affect the private economy in ways that are usually

accomplished by expenditures – in effect to produce an expenditure system described in

tax language.”38

Surrey subsequently supplied a convenient creation myth for U.S. tax expenditure

analysis. In September 1967, or two months before the speech, while sitting in a hearing

of the Ways and Means Committee of the House of Representatives, he ostensibly had

experienced a sudden “illumination.”39 The hearing had been called to assess President

Johnson’s proposal that a 10 percent income tax surcharge be enacted to help pay for the

Vietnam War. Many committee members, however, wanted to cut spending rather than

just raising taxes. They spent several days examining how this could be done, and

learning that it was harder than they had hoped:

For the moment, the committee, in its desire to see expenditures controlled
and thus make a tax increase more palatable if it must be voted, became an
Appropriations Committee. But in its scrutiny of the expenditures listed in
the budget, the committee had forgotten what it knew as a tax committee.
Never once in its examination of the direct expenditures listed in the budget
did the committee pause to consider the dollars involved in the tax incentives
and tax subsidies contained in the Internal Revenue Code.
It was not for lack of knowledge. The committee members were completely
aware that through tax benefits the income tax law provided financial
assistance to this or that business [as well as to state and local governments
and to such groups as the aged, the sick, and the blind] …. But the
committee kept the financial assistance furnished by these tax provisions

Quoted in Surrey, PATHWAYS TO TAX REFORM, supra n. __, at 3.
Id. at 3.

completely separated and isolated in its mind from the task at hand. Indeed,
the connection with that task simply did not occur to the members.40

The experience of sitting through this, Surrey tells us, “suddenly illuminated

many questions.”41 Could this gap in the members’ understanding be addressed? What if

he were to have the Treasury Department staff prepare a tax expenditure budget, parallel

to the official budget listings for direct expenditures? This would aid the policy process,

the next time spending cut issues arose, both by creating a ready list of special tax

provisions that really were spending, and by giving policymakers the numbers that they

would need to put these provisions on a par with direct spending in the budget process.

In actual fact, Surrey seems to have had something similar in mind as early as

1953, when he wrote a paper (apparently never published) criticizing “technical escape

routes [from the income tax] for favored groups” that Congress had deliberately enacted,

and quantifying at length the revenue lost due to these provisions.42 Moreover, for the

past year, the U.S. Treasury department had been devoting “substantial resources to

outlining the subsidy elements of the tax code. With Surrey’s approval, Gabriel G.

Rudney, a Treasury economist, had spent a year at the Brookings Institution43 working on

the question of how a tax expenditure budget would be presented. Rudney had even

produced a paper in August 1967, a month before Surrey’s sudden “illumination.”44

Surrey, supra n. __, at 1-2.
Id. at 3.
See Stanley S. Surrey, “Our Schizophrenic Income Tax,” 1953, p. 21, The Stanley S.
Surrey Papers, Harvard Law School Library, Modern Manuscript Division. Cambridge,
MA, Box 23, Folder 7. I am grateful to Dennis Ventry for bringing this paper to my
Jonathan Barry Forman, Origins of the Tax Expenditure Budget, 30 Tax Notes 537,
538 (1986).
See id at 538 n. 10.

The reason for the creation myth is easy to discern. Surrey’s stated motivation of

simply improving the budget process (the same motivation as that operating in Germany),

while undoubtedly sincere, was also somewhat anodyne. He had a more controversial

motivation as well. Tax reform, defined as broadening the base of the income tax so that

high-income taxpayers would pay more, had long been a personal cause of his. The tax

expenditure budget thus served for him as a tool of tax policy, not just budget policy. It

was meant to serve as a hit list, identifying provisions that should be repealed from the

tax code and either disappear altogether or else reappear as direct spending, and not just

placed on a par with direct spending whenever budgetary balance was being evaluated.

Back in private life (at Harvard Law School) once President Nixon had

succeeded President Johnson, Surrey soon made explicit his arguments against tax

expenditures. They generally were “upside-down subsidies,” unfairly aiding the rich

more than the poor, because their value depended on one’s marginal tax rate.45

Moreover, “by dividing the consideration and administration of government programs,

[they] confuse[d] and complicate[d] that consideration in the Congress, in administration,

and in the budget process.”46 A further concern, not always emphasized by him in this

setting, went to tax politics, which (even before his Treasury stay) he had observed was

dominated by special interest groups seeking narrow favors, without adequate

countervailing representation of the general revenue interest.47

From the start, therefore, tax expenditure analysis in the United States was both a

purportedly objective descriptive tool and a weapon of political combat. Surrey

Surrey, supra n. __, at 134-138.
Id. at 141.
See Stanley S. Surrey, The Congress and the Tax Lobbyists—How Special Tax
Provisions Get Enacted, 70 Harv. L. Rev. 1145 (1957).

expressly made certain political calculations, such as keeping off the list, for now, items

such as gifts and imputed rent whose inclusion would unduly have “puzzled” the public

because expert understanding that they were really income remained too “novel.”48 The

fact that he had a well-known political agenda – and, in a town like Washington, might

have been assumed to have one even if he didn’t – inevitably colored reception of the

idea. From the start it attracted controversy that, in Germany, where it was more of a

straight budgetary tool without the same perceived tax policy implications, it did not.

Under Surrey’s direction, the Treasury Department published its first tax

expenditure budget in 1968, although he was unable to get it included in the President’s

official budget. The Nixon Administration, being “cool to the tax expenditure concept”49

but not completely opposed, continued both to prepare estimates like those done under

Surrey and to deny them official status in the President’s budget. However, the

Congressional Budget and Impoundment Act of 1974, a response both to deficit concerns

and to turf wars between a Congress controlled by the Democrats and a weakened

President Nixon, made mandatory the inclusion of tax expenditure estimates both in the

President’s budget and in certain reports by Congressional committees.50

Tax expenditures were officially defined 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 provide a special credit, a preferential rate of tax,

or a deferral of tax liability.”51 As it happens, the German definition, though carrying

Surrey, PATHWAYS TO TAX REFORM, supra at 18. [But note no tax penalties, e.g., no
inflation adjustment, and double corporate tax subject to realization.]
Forman, supra n. __, at 541.
See id. at 544-545.
Public Law No. 93-344, 88 Stat. 297 (July 12, 1974).

less political freight, was not significantly different, apart from being terser. A 1970 law

defining “tax concessions” that must be estimated for purposes of comparison with direct

spending specified that they are “special exceptions to the general tax norm, which result

in shortfalls in receipts for the public sector.”52

In the end, then, aided by the fortuity of the Watergate crisis, tax expenditure

analysis won official recognition in the United States notwithstanding the controversiality

that it derived from its association with a particular tax reform agenda. This did not,

however, mean that it had avoided the taint of being viewed in many quarters as a

tendentious exercise in furtherance of that agenda. Boris Bittker – the tax law’s great

“fox” who saw many things, and scourge of all the “hedgehogs” who saw one big thing –

had dealt the heaviest blow back in 1969, when he pounced on Surrey’s call for a “full

accounting” of expenditure items in the income tax law.53 The accounting was far from

full, Bittker noted, and the decisions regarding what to include and exclude were

arbitrary. Worse still, many rules’ status as tax expenditures or genuine tax rules simply

could not be ascertained, due to the lack of an “agreed conceptual model” for the

spending-free income tax.54

In fact, Bittker’s article is more of a “Yes, but” than a “No,” because he agreed at

the end that “a more limited accounting” could be useful, “provid[ing] information that

would be helpful in applying our political, economic, and ethical criteria in making

policy judgments about the income tax system.”55 However, it was a “Yes, but” in which

the “but” came first and accounted for 16-3/4 of the article’s 18 pages. Bittker may

See Shannon, supra n. __, at 205.
Bittker, supra n. __.
Id. a 258.
Id. at 260-261.

therefore have played an important role in conveying the message that experts were split

about the cogency of tax expenditure analysis, and that the analysis was more partisan

weapon than objective descriptive tool. Then again, given the role Surrey unmistakably

wanted the analysis to play in prompting a certain kind of tax reform, perhaps this

reception was inevitable among those who did not share his vision.

The other big objection to tax expenditure analysis that colored its acceptance was

its supposed implication that “our money belongs to the government, and that the

government is doing us a favor by not taxing it.”56 This is not a correct criticism unless

the “normative tax” that is being used to define “spending” applies at a 100 percent rate

to all of our money. Tax expenditure analysis identifies differences between the tax

treatment of different items, and assumes no taxation in excess of that which the

government actually applies to something – although concededly it benchmarks the

treatment of higher-taxed items, and has not traditionally been used to measure instances

of over-taxation or tax penalty.

Still, once one sheds spending illusion, tax expenditure analysis can aid an anti-

government agenda, by helping to identify government interventions in the economy,

such as the “targeted tax cuts” of which President Clinton was so fond. The government

is presumably a lot bigger allocatively, for example, if it imposes high tax rates that are

subject to numerous exceptions, than if it raises the same revenue, with the same overall

progressivity, through lower rates that are subject to fewer exceptions and thus do far less

to steer investment into favored activities.

Thuronyi, supra n. __ at 1178 (noting that “[p]oliticians commonly attack the tax
expenditure concept” on this ground).

Is spending illusion the only reason conservatives have often been hostile to tax

expenditure analysis? Certainly it is a big part; the illusion is so tenacious that even

Nobel Prize-winning economists, such as Gary Becker and James Buchanan, succumb to

its siren lure.57 Conservatives may also have been responding, however, to the liberal

political agenda of many liberal supporters of tax expenditure analysis. Stanley Surrey,

for example, “felt very strongly that the tax system should be sharply progressive, and he

regarded ‘all the Mickey Mouse stuff in the Code as attenuating the progressivity of the

rate structure.’”58 Tax expenditure analysis may therefore have been viewed as a stalking

horse for greater progressivity (rather than for distributionally neutral base-broadening),

implying a larger government in distributional terms even if the government’s allocative

effects were reduced.

The end result of all these cross-currents has been a state of affairs in which tax

expenditure analysis lacks the real acceptance one might have expected from its

enshrinement in official reporting requirements. Its status as an objective descriptive tool

has been seriously undermined by the Bittker line of criticism, which is frequently

repeated and has not been effectively answered. Moreover, Bittker did not even make

one of the strongest criticisms of all, if we interpret the analysis as resting on a distinction

between “real” taxes and “real” spending that even he (at least as to the latter) did not

think to challenge. If taxes and spending are themselves arbitrary categories, then the

See Gary S. Becker and Casey B. Mulligan, Deadweight Costs and the Size of
Government, National Bureau of Economic Research Working Paper 6789 (1998)
(arguing that countries with less efficient tax systems have smaller governments because
they spend less); Shaviro, DO DEFICITS MATTER, supra, at 103 (Buchanan and kindred
theorists “show their misunderstanding when they treat the imposition of excess burden
through taxation as an alternative to feeding Leviathan rather than as en example of
Leviathan at work”).
Forman, supra n. __, at 538.

critique that a given tax rule is really spending does not quite state correctly the point that

underlies the WSTC example.

As a weapon of political combat, tax expenditure analysis seems to have been

compromised by over-reaching. Effective fiscal language weapons must generate

widespread acceptance of their structure and implicit norms in order to do their work.

Thus, when President Clinton spoke of “saving Social Security” (defined as keeping the

official budget surplus at least as great as the Social Security surplus), neither the goal

nor his definition of what it implied were effectively challenged until he ceased to be on

the scene demanding it.59 Tax expenditure analysis seems instead to be viewed in many

circles as logically dubious special pleading in support of a particular policy agenda.

Things have simply remained stuck in this posture for the last thirty years, and with the

volume of the literature exceeding its production of fresh insights.

This controversy is particularly American, and seems not to have accompanied

the use of tax expenditure analysis elsewhere. In other countries, the analysis has been

considerably less controversial, reflecting distinct national histories in which neither

Surrey-style tax reformers nor anti-tax and anti-government ideologies play as large a

role as they have in the United States. Lesser controversy, however, seems to have been

accompanied by less extensive inquiry into the underlying definitional problems60 and

their significance for how official measures should be interpreted.

[This notwithstanding silliness of the definition, as per MAKING SENSE OF SOCIAL
See Shannon, supra n. __ at 204-205 (noting that, “because tax expenditures are
viewed as legitimate means of implementing social and economic policy in Germany ….
definitional issues have received much less attention” there than in the United States);
OECD Report at 11-14 (noting countries’ widely differing approaches to defining tax

The time is ripe, therefore, for reexamining the premises of tax expenditure

analysis, with an eye to its fiscal language prongs both as a tool for attempted objective

description and as (inevitably) a weapon in political combat. I begin with the former

prong, and with a more abstract approach than that which generally has been used in


B. Rationales for Re-Describing Actual Tax Rule A as Hypothetical Tax Rule

B Plus Spending Rule C

1. Choosing Between the Infinite Possible Counter-Factuals

Tax expenditure analysis rests on an equivalence. Tax Rule A, it suggests, is

really a spending rule, and should thus be restated as hypothetical Tax Rule B plus

Spending Rule C, which in combination are equivalent to it. If the rule at issue is

something like the WSTC, which one has determined ought not to be in the tax system to

begin with, the process of re-description is relatively simple. Tax Rule B is simply the

absence of any such rule, and its entire revenue consequences are attributed to its re-

described form as Spending Rule C. However, if the tax rule is “wrong” yet there ought

to be some tax rule – as in the case of accelerated depreciation, if one determines that it

exceeds “correct” tax depreciation (such as economic depreciation) – then the process is

more cumbersome. One must do more work in specifying hypothetical Tax Rule B

before we can attribute its net revenue loss, relative to actual Tax Rule A, to hypothetical

Spending Rule C.61

Estimates of the cost of tax expenditures generally are done on an ex post rather than
an ex ante basis, to measure the amount by which revenues actually were reduced by the
provisions given the investments that taxpayers made. See OECD Report at 14. They
thus differ from, and will often exceed, the revenue gain that would result from repealing

So long as hypothetical Rules B plus C are indeed equivalent to actual Tax Rule

A, the exercise is tautologically correct. To have any significance, however, the

restatement needs to be motivated. After all, we could just as easily decompose Tax Rule

A into the even more favorable Tax Rule D (say, triple WSTCs) plus Negative-Spending

Rule E (requiring the taxpayer to refund two-thirds of the triple WSTCs). Tax Rule A

could then be described as a tax penalty relative to D, as measured by E. One thus needs

to explain why a particular counter-factual should be chosen from among the infinite

possibilities as capturing the “true” character of the actual observed Tax Rule A.

In practice, the claim that actual Tax Rule A is actually hypothetical Tax Rule B

plus Spending Rule C, rather than some other pair of hypothetical rules that would add up

the same, rests on the further claim that, if the legislature had only meant to raise revenue

under its general policy for doing so, B is what it would have enacted. This claim is easy

enough to credit when A is the WSTC and B is its absence. Even for cases as easy as

that, however, the claim ought to be stated more generally.

In the effort to make sense of it, we can take either of two approaches: a broader

one that reinterprets what we might mean by taxes and spending, and a narrower one that

discerns a general character to particular sets of tax rules, such as the “income tax” or the

“motor vehicle tax.” Each approach has both advantages and limitations, and they should

be considered complementary rather than competitors.

the provisions, with resulting reallocation of investment away from items that are no
longer being taxed as favorably.

2. A Broader Approach: Defining Tax Expenditures Relative to a

“Tax System” That Serves General Distributional Purposes

Under a more broadly theoretical approach than that which is typically used, the

tax system might be defined in terms of function, rather than of the direction of cash flow

between taxpayers and the government. It provides an important mechanism for dividing

equitably the costs of government, and more broadly “put[ting] into practice a conception

of economic or distributive justice.”62 We might have an income tax, for example, not

because we want to penalize or discourage earning income, but because we think of

income as evidencing ability to pay, which has been selected as the proper criterion for

distributing the costs of government.

From this perspective, taxation closely overlaps with something identified by

Richard Musgrave, in his famous tripartite conceptual division of the public sector into its

allocation, distribution, and stabilization functions.63 Along with certain transfers

(negative taxes in Musgrave’s parlance), it does the work of the distribution branch.

Indeed, that is all it deliberately does to the extent that its allocative effects, such as on

work and saving, are unintended byproducts of advancing distributional aims.

Identifying the “tax system,” as the term is used in tax expenditure analysis, with

Musgrave’s distribution branch is subject to several objections. One is that Pigovian

taxes, such as a pollution tax meant to give polluters socially optimal incentives, clearly

involve the allocation branch, yet nonetheless are “taxes” in common usage and could

conceivably have tax expenditure budgets. Second, allocative considerations could in

Musgrave, supra n. __, at v.

principle be integral to decisions by the distribution branch. Suppose, for example, that

the legislature very slightly preferred income taxation to consumption taxation from a

purely distributional standpoint, yet enacted a consumption tax due to concern about the

effect of the income tax on saving. Would we not then say that the “tax system” used a

consumption tax, rather than an income tax accompanied by spending rules to reverse its

discouraging effect on saving? Nonetheless, identifying the tax system with Musgrave’s

distribution function goes a long way to help explain the tax expenditure concept. We

can readily grasp that the WSTC is allocative rather than distributional, as is accelerated

depreciation if – an important qualification that I modify below – we assume that

economic income would be taxed but for the aim of subsidizing a particular set of


Calling the WSTC an allocative provision, and thus not part of the “tax system”

as defined in a Musgravean sense, requires a clarification of what we mean here by the

“distribution branch.” Suppose it were established that the weapons being purchased by

the government through the WSTC were worthless, and that the reason for the enactment

was simply to benefit the companies that were getting the credits. Suppose even that this

motivation were overt (say, to rescue troubled companies), rather than involving

deception of the public by legislators and lobbyists. We presumably would not reclassify

the WSTC as being part of the tax system after all, even though its motivation would then

be distributional. After all, so reclassifying it would imply that, when interest groups

strongly influence the enactment of a preferential tax rule, the case for treating the rule as

a tax expenditure is weakened. Yet this presumably is the opposite of what advocates of

tax expenditure analysis have in mind, and no one would suggest reclassifying spending

as “really” taxation when interest groups use it to line their pockets. Accordingly, the

distribution branch, insofar as it is being used to define the “tax system” for tax

expenditure purposes, should be thought of as limited to acting on the basis of broad

equitable considerations, such as those involving inequality or ability to pay.

Examples from the tax expenditure debate in the United States help to show both

the importance and the limits of this broad approach to defining tax expenditures. An

early controversy concerned whether medical deductions were properly classified as tax

expenditures in the official accounts. William Andrews argued that the deductions

should not be so classified, on the ground that they were an appropriate adjustment in

measuring ability to pay. In form, he was making an argument about the treatment of

medical deductions in an “ideal income tax.” In substance, however, he recognized that

his argument depended, not on the dictionary meaning of income as such, but rather on

the broad distributional relevance of incurring medical expenses.64 Whether one agrees

or not with Andrews’ analysis, he was raising the right type of question, and one that

required considering the broader Musgravean distributional function.

On the other hand, consider the United States rules under which interest on

municipal bonds, or those issued by state and local governments, is generally tax-exempt,

whereas other interest income is generally taxable. One cannot say which of these two

approaches to taxing interest income is correct, from the standpoint of the Musgravean

distributional branch, unless one is prepared to wade into the decades-old controversy

concerning the choice between income and consumption taxation. One can, however,

easily see that the contrast between the tax treatment of municipal bond interest and other

William Andrews, Personal Deductions in an Ideal Income Tax, 86 Harv. L. Rev. 309

interest makes no sense in purely distributional terms. A dollar in hand is a dollar in

hand, so the disparity could only be defended on allocative grounds, presumably as a way

of favoring debt-financed activity by state and local governments relative to other

investment. So tax expenditure analysis ought to apply here somehow, but one needs

more than just the Musgravean benchmark to apply it, unless one is prepared to assert –

more controversially than the point about inconsistency seems to require – that either the

income tax or the consumption tax approach to interest income is correct from a broad

distributional standpoint.

Several further examples may help in showing how the Musgravean distributional

perspective might illuminate various familiar problems in applying tax expenditure

analysis to various features of existing income taxes.

Adjustments for Household Characteristics – The principal adjustments for

household characteristics in the United States income tax include (1) distinct filing

statuses for married individuals, single individuals, and unmarried heads of households

(with implications for such features as the width of lower rate brackets), (2) deductions

called personal exemptions for each qualifying member of the household, and (3) the

allowance of child tax credits. As it happens, only the last of these is officially treated as

a tax expenditure, although a view that personal exemptions ought to be on the list might

be inferred from their being disallowed under the alternative minimum tax, which applies

a lower rate to a broader base, ostensibly to prevent tax preferences from unduly reducing

one’s tax liability relative to one’s economic income. Bittker noted that all adjustments

for household characteristics are potentially up for grabs in defining the tax expenditure


From a broad Musgravean perspective, two points should be clear. The first is

that household characteristics, like earnings and (under some views) medical expenses,

plainly are relevant to the operations of the distribution branch. For example, in

assessing a given individual’s material wellbeing, all household resources, not just those

that he or she personally owns, are potentially relevant. Mrs. Bill Gates is unlikely to

need public assistance even if she earns nothing. Moreover, it is certainly plausible

(whatever view one ultimately takes) that, as between two individuals or couples with the

same income, a distributional adjustment might be appropriate if one had seven children

and the other none.66 Thus, in basing tax liability on household characteristics, we are in

the realm of reasonable disagreement about the distribution function.67 Thus, all of these

rules – even more clearly than medical deductions, and unlike the WSTC – can be

thought of as reflecting reasonable views about the distribution branch. Second,

differences in the means used to adjust for household characteristics (for example, the use

of a credit versus a separate filing status that affects the width of rate brackets) have no

Bittker, supra n. __, at 253.
Moreover, a household’s rules for allocating resources among its members may affect
the incidence of a tax or transfer. Suppose, for example, that we wanted to start taxing
male chauvinist husbands while aiding their wives. Any attempt to do this would have to
take account of the possibility that the chauvinists would end up with the same share of
household resources as previously. A further point supporting the relevance of household
characteristics to distribution is that the aggregate wellbeing of two or more individuals
in a household might differ from that of the same number of individuals with the same
total earnings who are not together in a household. Consider, for example, the issue of
whether cohabiting couples enjoy economies of scale that might be distributionally
However, a particular adjustment for household characteristics might reasonably be
viewed as going beyond the realm of reasonable disagreement. Suppose, for example,
that married couples with children were wholly exempted from all taxes.

direct bearing on this conclusion. It is hard to see, for example, why the distribution

branch would be confined to using rate bracket adjustments rather than credits. Thus, it

is hard to see why their form should dictate which (if any) of them are treated as tax


“Classical” System for Taxing Equity-Financed Corporate Income – Countries,

such as the United States, with an at least partly “classical” corporate income tax system

impose tax on certain corporate earnings twice: first at the corporate level, and then again

at the shareholder-level when after-tax corporate earnings are distributed. Is this properly

attributed to the Musgravean distribution branch? That depends on how one interprets

the question.

On the one hand, the distribution branch can only distribute tax burdens among

individuals, even if it sound administrative practice suggests classifying corporations as

taxpayers. A disparity between the tax burdens on corporate and noncorporate

investment (or between debt-financed and equity-financed corporate investment) would

appear to be on a par, from a straight distributional standpoint, with disparate taxation of

municipal bond interest and other interest. From this perspective, one might conclude

that double corporate taxation should be classified as a negative tax expenditure or tax


On the other hand, the double tax may reflect voters’ genuine though mistaken

belief that corporations, like flesh-and-blood individuals, actually can bear tax burdens.

It also may reflect some policymakers’ belief that double corporate taxation is a

politically convenient way of increasing the progressivity of the fiscal system. And it

may reflect administrative considerations in operating the distribution branch, if not only

collecting tax at the corporate level but denying relief at the shareholder level aids

enforcement and reduces complexity. In addition, if we asked Surrey’s question, at the

moment when he supposedly first thought of tax expenditure analysis, of whether the tax

rule reflected deliberative allocative policy of a sort that typically is left to appropriations

committees, we might be inclined to say no. From these perspectives, one might

conclude that double corporate taxation should not be classified as a negative tax

expenditure or tax penalty.

Given these conflicting perspectives, the answer to how double corporate taxation

should be classified depends on the questions that one is trying to illuminate through tax

expenditure analysis. Depending on one’s purposes, one could define the Musgravean

distribution branch in various ways. For example, is one interested in what a relatively

idealized distribution branch would do, or in its operations as constrained by popular

confusion, political calculation, and administrative problems? Is one concerned about tax

rules that might, as a practical matter, alternatively involve appropriations, or all those

that have allocative effects other than on work and saving (or indeed any allocative

effects whatever)?

Realization Requirement and Lack of an Inflation Adjustment – A tax on

economic income would reach unrealized fluctuations in asset value. It also would adjust

comprehensively for price level changes, so that nominal inflationary gain would not be

treated as having made one better-off. An income tax that makes neither of these

adjustments arguably includes a tax expenditure with respect to unrealized gain, and a tax

penalty with respect to unrealized loss and the lack of an inflation adjustment. On the

other hand, these features of most actual income taxes might be rationalized as reflecting

administrative considerations that bear on the distribution branch. Or they might be

rationalized as ad hoc adjustments (going in opposite directions) either to the

progressivity of the fiscal system or to the tax burden on saving that distinguishes an

income tax from a consumption tax. Certainly it is hard to imagine Surrey’s tax

committees imposing an inflation-adjusted tax that reached unrealized gain and loss as

part of a mere reallocation of functions between the tax and appropriations committees of

the legislature (with the latter being expected to respond with suitable adjustments to

“spending”). The definitional problem therefore resembles that presented by double

corporate taxation in requiring further specification of the purposes that tax expenditure

analysis is meant to serve.

* * * * *

In sum, tax expenditure analysis can be rescued from the vacuity of the distinction

between taxes and spending if we reinterpret it to identify provisions in the tax laws that

Musgrave’s distributional branch would be unlikely to employ when acting on the basis

of broad equitable considerations.68 From this perspective, we can see that it is

reasonable to classify the WSTC, but not the allowance of ordinary business deductions,

as a tax expenditure. The proper classification of some items, such as medical

deductions, is reasonably debatable, while for others, such as interest income, the proper

result is reasonably debatable but certain disparities in the law seem clearly to reflect a

“spending” (i.e., allocative or narrowly distributional) motivation. One also needs greater

In the case of a Pigovian tax, one would have to rely instead on the broad allocative
purpose of the tax. Thus, if pollution were generally taxed but with an exception for
cement factories that had nothing to do with distinctions between their pollutants and
those emitted by other factories, we might call this a tax expenditure whether the aim was
to benefit cement factory owners (a narrow distributional goal) or to increase cement
production (an allocative goal distinct from that of the tax).

specification of the purposes of tax expenditure analysis in order to classify tax rules that

are clearly “wrong” distributionally but that might reflect tax administrative concerns.

The Musgravean distributional approach is therefore helpful although by no

means conclusive. It helps to show, moreover, that Bittker’s critique of tax expenditure

analysis was overstated, unless one confines the critique (as Bittker perhaps intended) to

rebutting overstated claims that one particular rendering of the “true” distribution system

is canonical. Although we lack an agreed conceptual model of exactly what the

distribution branch should do, we do not lack widely shared approaches to how we

should think about what it is trying to do. Bittker was too swayed by the American

setting, in which tax expenditure analysis related to a particular set of controversies

concerning progressivity, the size of government, and income tax reform.

3. A Narrower Approach: Discerning the “Normal” or “Normative”

Contours of a Particular Tax Base

Even if the Musgravean distributional approach provided fuller guidance than it

does, it might sound too woolly-headed to be used officially. Not surprisingly, then, tax

expenditure analysis generally uses a more modest and practical-sounding approach to

identifying the “non-tax” rules in a tax system. This generally involves identifying the

“normal” or “normative” features of a given set of tax rules, based on the “concept of a

normative tax of the type under consideration.”69 Features that vary from the ideal but

serve administrative purposes, such as the realization requirement in an income tax,

typically are built into the “normative tax.” Classifications may also be influenced by

such factors as whether a “tax concession … benefit[s] a particular industry, activity, or

Stanley S. Surrey and Paul R. McDaniel, TAX EXPENDITURES 3 (1985).

class of taxpayer,”70 and whether it could as a practical matter be moved outside the tax

system, such as through the adoption of a direct spending rule.

To an extent, relying on the “normal” or “normative” form of a given tax base,

rather than on broadly gauged distributional concerns, simply hides the ball. For

example, it may cause the double corporate tax, realization requirement, and lack of an

inflation adjustment to be built into the “normative” baseline without sufficient

consideration of their decidedly non-normative character, which might influence one’s

thinking about special exceptions to them. Moreover, to determine the content of a

“normative tax of the type under consideration,” as distinct from the tax we actually

observe (which by definition is what it is, and thus would have no “tax expenditures” if

used as its own reference standard), we must to some extent ask the very same questions

as under the Musgravean analysis. Consider the tax expenditure budgets that thirty-three

American states (plus the District of Columbia) publish with respect to their sales taxes.

Several states classify exemptions from the sales tax for inter-business transactions as tax

expenditures.71 To explain why this is wrong, one must look to the broader question of

what the distribution branch might reasonably use a sales tax to do – i.e., “produce a

uniform distribution of the cost of government according to levels of household

consumption expenditure,”72 as distinct from favoring vertically integrated production

relative to that involving transactions between separately owned businesses. So we

cannot entirely avoid the broader questions by appealing to the contours of a particular

well-known tax base.

OECD Report, supra n. __, at 9.
See John L. Mikesell, The Normal State Sales Tax: The Vision Revealed in State Tax
Expenditure Budgets, 2003 State Tax Today 66-4.

Focusing on a “normative tax of the type under consideration” does, however,

have certain advantages where the features of the “type” have attracted sufficient

consensus. Suppose, for example, that a sales tax exempts a particular consumer good, in

addition to (as a sales tax) generally exempting returns to saving such as interest income.

An advocate of comprehensive income taxation, who favored taxing the excluded

consumer good and returns to saving in addition to everything in the existing sales tax

base, might nonetheless find it useful to distinguish, through the tax expenditure measure,

between the two types of exclusion. The exclusion of the consumer good might support

different inferences about the likely political process (perhaps involving interest group

politics) than the fact that the tax was a species of consumption tax rather than an income

tax. In addition, even if one believed (contrary to most observers) that consumption taxes

are generally more distortionary than income taxes, one might find it convenient to

distinguish between the economic distortions that one attributed to choosing the wrong

base and those that one attributed to taxing consumption unequally. (For example,

people who disagreed about the former claim of distortion might nonetheless agree with

the latter claim.) Accordingly, a measure that identified the exclusion of the consumer

good while ignoring the divergence from income taxation might be useful and

informative. The battle (in broader Musgravean terms) between the two rival tax bases

might simply be regarded as extraneous for this purpose.

The narrower approach also has problems, however, which have been starkly

exposed in the American income tax setting. It is a truism that the United States income

tax is in fact a “hybrid income-consumption tax”73 (while also having features that are

consistent with neither). In a whole host of examples, a preference from the income tax

perspective, such as excluding municipal bond interest or unrealized asset appreciation, is

correct from the consumption tax perspective. It also is far from clear that the system as

a whole is closer to income taxation than to consumption taxation. Moreover, the

question of which system is better is continually in play politically. Even when the

prospect of enacting an explicit consumption tax seems politically remote – as usually it

does – the relative merits underlie political battles about matters ranging from tax-free

savings accounts to depreciation and other cost recovery rules to corporate integration.

Against this background, Surrey successfully argued early on that the official tax

expenditure estimates he was seeking should be conducted solely from an income tax

perspective. He presented this argument in ostensibly neutral terms, and wholly without

reference to his own well-known support for income taxation:

Each tax has its own appropriate structure and each has its advantages and
disadvantages. But the scope of each such tax in its actual application must
be tested by its concepts, which concepts led to its choice in the first instance.
The structure of a normative income tax is not to be tested by the values or
concepts used by those who prefer that a consumption tax be chosen instead,
and vice versa. A tax expenditure budget for an income tax, to be useful in
seeing what objectives that tax has been asked to carry in addition to taxing
net income, is to be framed by using a normative definition of “income.”74

See, e.g., Henry J. Aaron, Harvey Galper, and Joseph A. Pechman, (eds.), UNEASY
Surrey, PATHWAYS TO TAX REFORM, supra n. __, at 21.

In other words, we actually have an income tax – that is what we have enacted – so

income tax principles must be used in the tax expenditure budget whether they are right

or wrong, until such time as a consumption tax is officially enacted.

Formally speaking, the argument here is identical to the one I outlined above

concerning the sales tax under which the exemption of a particular consumption good,

but not the exemption of returns to saving, might reasonably be treated as a tax

expenditure. The surrounding circumstances are different, however. Purely from the

standpoint of internal logic, it is not entirely clear that what we have is best classified as

an income tax. Moreover, any inference that departures from it must reflect allocative or

narrowly targeted distributional policy is weakened where the departures can be

explained as reflecting a consumption tax approach that is known to have wide appeal.

Even if one nonetheless accepts Surrey’s argument, the brute fact is that, in a

crucial sense, it did not prevail. His success with regard to official reporting of tax

expenditures was not accompanied by the kind of widespread acceptance of the analysis

that he sought. This is no surprise. Consumption tax advocates, who frequently have

been hostile to tax expenditure analysis75 even though they share Surrey’s goal of taxing

alternative kinds of consumption and saving more neutrally, could plausibly interpret his

arguments as amounting to the following: “Please forget for the moment that I am an

income tax advocate. I want you to accept as normative the type of tax that we officially

have, which I know you do not like, because we have it, and even though in fact we do

not have it. I will of course do the same for you, either in comparatively trivial settings

See, e.g., Institute for Research on the Economics of Taxation, IRET Congressional
Advisory No. 95, “What’s Wrong With the Tax Expenditure List/How to Fix It (January
6, 2000); Bartlett, supra n. __; Norman B. Ture, “Unreleased Testimony on Tax
Expenditures,” Tax Notes, December 21, 1981, page [1535].

under present law (such as state sales taxes) or if you win outright at the federal level,

which we both know is highly unlikely. Please do not be swayed by the fact that, by

accepting the income tax as normative for these purposes, you may help me to win our

ongoing disputes concerning whether the existing system should be made more income

tax-like or more consumption tax-like.”

This is hardly an offer one cannot refuse. The suspicion that tax expenditure

analysis served unacknowledged and controversial political agendas may further have

been heightened by several others of its key features, as practiced in the United States

income tax setting. One was its one-way ratchet in measuring tax expenditures but not

tax penalties. Another was its treating double corporate taxation as the norm, on the

ground that it was a merely structural feature of the U.S. system, when this was not even

consistent with neutral income taxation. Here was another feature of the existing tax

system that Surrey, among others who shared his backing for greater progressivity, just

happened to support.76 While various pro-taxpayer deviations from a theoretically pure

Haig-Simons77 income tax were also built into the “normal income tax structure” – for

example, not taxing unrealized appreciation or homeowners’ imputed rental income –

these omissions might be considered expedient rather than genuinely even-handed.

Surrey had even suggested that such items might be added to the official list once the

public was readier to understand and accept their inclusion.78

In the meantime, Surrey had left himself open to such critiques as the following:

“[H]aving abandoned the purity of Haig-Simons, [he] is adrift in a sea of value judgments

[Cite for Surrey’s support for the double corporate tax.]
See Henry C. Simons, PERSONAL INCOME TAXATION 50 (1938) (defining “income” as
one’s consumption plus change in net worth during the relevant accounting period).
Surrey, PATHWAYS TO TAX REFORM, supra n. __, at 18.

and his is no better than any other expert’s. Thus, it is presumptuous for him to label his

definition (i.e., the Treasury’s) as the one correct definition, any deviations from which

will be labeled tax expenditures.”79 Such critiques could not be fully rebutted by arguing

that, say, the realization requirement really is “structural” to the income tax in the sense

of serving administrative aims and not being readily transmutable into a direct spending

program. Nor would it have helped, even if Americans were generally more interested in

what other countries do, to point out that similar approaches to tax expenditure analysis

are followed elsewhere without arousing similar controversy. The setting was simply too

politically loaded for a creature as unlovely (and unloved) as the “normal income tax

structure” to win requisite acceptance as the one and only baseline for measuring

presumptively suspect deviations.

In short, the problems with using a “normative tax of the type under

consideration” came home to roost because it combined being innately too controversial

with having too many compromises built into the particular implementation that was

being used. Not sufficiently respected as an objective descriptive tool, it could not

function effectively as a political weapon. By keeping fundamental distributional issues

too far from center stage, on the insufficiently accepted ground that they have been

wholly resolved for purposes of the particular tax at issue, U.S. proponents of tax

expenditure analysis unduly limited its capacity both to provide interesting information

and to attract the acceptance that it would have needed to work as hoped.

Bartlett, supra n. __, at [415?]. [Cite also Bittker & the Ture quote in Bartlett.]]

C. Design in Light of the Purposes of Tax Expenditure Analysis

Tax expenditure analysis is too inherently flexible a tool to have only one or a

single set of narrowly defined purposes. Restating actual Tax Rule A as hypothetical Tax

Rule B plus Spending Rule C need only be interesting and informative in order to be

justified, since it is tautologically correct if C is defined as the positive or negative outlay

that is needed to reconcile A with B.

Even if we limit ourselves to restatements that bear some relationship to historical

uses of the tax expenditure concept (on the ground that some other term should be used if

we are engaged in something entirely distinct), we retain considerable flexibility. For

example. we might interpret the juxtaposition of “tax” and ‘expenditure” more

subjectively, or in terms of legislators’ known or presumed intent, if we want to identify

cases where it seems that tax rules are deliberately being used to have allocative or

narrowly distributional effects of a kind that often are done through direct spending. Or

we might interpret the juxtaposition more objectively, as identifying such effects even

where the tax rule might be strongly influenced by administrative considerations. The

proper choice of emphasis may depend on where one’s interests lie, as between budget

policy and tax policy.

From a purely budgetary standpoint, like that underlying Surrey’s creation myth

and the actual German history of tax expenditure analysis, one might mainly be interested

in provisions that, as a matter of presumed intent and/or convenient design, could

alternatively be done through “spending.” For example, if one is trying to reduce budget

deficits, one might want to place narrowly crafted special tax benefits on a par with

appropriations, while not being greatly interested in the gap between realized income and

economic income. Even from such a perspective, however, one might want to be

apprised of the differences between provisions such as the WSTC that clearly have no

place in a Musgravean distribution system, and those that might conceivably be so

rationalized, whether because they reflect a consumption tax approach or otherwise (like

medical deductions and household adjustments) raise reasonably contestable

distributional issues.

If we add a tax policy perspective to our underlying set of interests, then all

arguable or clear departures from the “ideal” Musgravean system are of interest, whether

or not they could be converted into direct spending. Thus, one might want to compare

the existing U.S. “income” tax to a pure Haig-Simons income tax, and also to a broad-

based consumption tax.80 Under a tax policy perspective, moreover – seemingly the

dominant one in American uses of tax expenditure analysis – the aim of offering more

information, rather than less, would be advanced by making reasonable distinctions in the

accounts. For example, even if one includes medical deductions on the ground that they

are possibly or in some views a tax expenditure, one might want (no less than under the

budgetary perspective) to distinguish between them and provisions that (after the fashion

of the WSTC) are unambiguously “spending.” One also might want to distinguish clearly

structural provisions (such as the realization requirement or lack of an inflation

adjustment), as well as those that are arguably structural (such as the classical corporate

tax), from those that are more like the WSTC. So the main difference between the

One could go deeper still. For example, if one thinks that we tax income or
consumption only because they are signals of some underlying attribute, such as “ability”
or “endowment,” that cannot be directly observed,80 then one might be interested in a
revenue estimate for the cost of failing to tax ability that is unexercised by reason of the
tax disincentive to work.

budgetary and tax policy perspectives is simply that, under the latter, somewhat more

information is potentially interesting.

The argument I am making here for more varied and informative tax expenditure

analysis would approach banality (who wants to argue for less information?) if the United

States history of the analysis were different. Indeed, various countries provide alternative

benchmarks and distinguish structural provisions, or those whose classification as

“spending” is relatively ambiguous.81 In the U.S. income tax setting, however, the

analysis has been sufficiently waylaid by the aftershocks from Surrey’s initial decision to

present it as a purely budgetary tool, rather than as a tool in both budgetary and tax

policy, that such a proposed revision verges on the radical. Proponents of Surrey-style

income tax reform may be reluctant to surrender the preeminence of their view within the

official reports, however doubtful the advantages that they gain therefrom. And some

opponents of the Surrey view may be too hostile to the analysis in all forms – whether out

of reflexive distaste based on its history, or spending illusion, or because they actually

want to diminish publicly available information – to be interested in its revision and

indeed expansion. Perhaps there are grounds for optimism, however, in light of the

Treasury Discussion, which I examine next.

Before turning to that discussion, however, it is worth briefly mentioning what

makes tax expenditure analysis potentially so valuable. Its mode of description may help

to counter the undue political advantage, in some settings, of doing allocative policy or

narrow distributional policy through the tax code. Surrey’s story about sitting in the 1967

Ways and Means hearing, the details of which are entirely believable even if it was not

See OECD Report at 10.

really the moment when he conceived of tax expenditure analysis, describes only a trivial

(because easily corrected) manifestation of the problem, in the form of political actors not

recognizing the practical interchangeability of tax and appropriations rules.

The deeper problem, especially after thirty years of tax expenditure analysis, is

not that policymakers fail to recognize the practical interchangeability of tax rules and

spending rules. Nor is it that they fail to give tax rules significant scrutiny, even though

once enacted tax rules generally do not have to be reenacted annually in the manner of

discretionary spending. It is well documented that tax expenditures often get extensive

ongoing scrutiny.82 The main problem that tax expenditure analysis may help to address

lies, rather, in the speciousness of the otherwise prevailing fiscal language distinction

between “taxes” and “spending.” Supposed tax cuts are perceptually different than

supposed spending,83 even if the two are substantively identical, for reasons that include

but are not limited to anti-government ideology as applied through the lens of spending

illusion. A deeper cause is the heuristic bias that decision researchers call the endowment

effect, under which people systematically under-weight opportunity costs relative to

equivalent out-of-pocket costs. This effect “induces people to draw an exaggerated

distinction between money that is never paid in to the Treasury and money that is first

paid in and then taken back out.”84

TAX 334 (1985).
See, e.g., Martin A. Sullivan, Tax Expenditure Budgets, Now More Than Ever, 86 Tax
Notes 1187, 1188 (“During the 1990s, President Clinton has perfected a political tactic
that has done wonders for the Democratic party, but at the same time it has complicated
the tax code. Tax-and-spend liberalism has been replaced with "tax expend" liberalism.
Rather than directly funding new government programs, the president knows that
politically it is far easier to implement social programs through the tax code.”).
Shaviro, WHEN RULES CHANGE, supra n. __, at 87.

The endowment effect might not work politically in favor of using the tax code if

the beneficiaries from tax breaks were as subject to it as the general public. They might

then think that they were getting less from a tax break, just as the public gets the

impression that it is giving less. Heuristic biases, however, work more powerfully when

one’s attention to an issue is relatively casual. The direct beneficiaries of tax benefits can

therefore readily grasp that an extra dollar in their pockets is a dollar either way. The

target, when tax rules are used to exploit the endowment effect, is the general public,

which pays far less attention but is always a looming presence on the scene, capable of

inducing rejection of transfers that break through the haze to attract hostile scrutiny.85

Countering this perceptual bias through a reformulation of our fiscal language is

the big contribution that tax expenditure analysis can potentially make. And while this

falls in the “weapon” category of fiscal language uses, since it aims to affect political

outcomes rather than simply offering analytically interesting description, it is “weaponry”

of a sort that can withstand scrutiny. Not only is it intellectually defensible unless one

sees no difference between the WSTC and measuring income for broad distributional

purposes, but it aims to improve understanding, rather than seeking to dictate a given

controversial result. There is no necessary implication that tax expenditures must be

eliminated, only that we should think about them differently than the usual “tax” and

“spending” categories imply. Thus, while those who want more use of the tax code,

rather than less, to camouflage policies that otherwise might involve direct spending, may

See Daniel Shaviro, Beyond Public Choice and Public Interest: A Study of the
Legislative Process as Illustrated by Tax Legislation in the 1980s, 139 U. Pa. L.Rev. 1,
40-42 (1990).

have reason to oppose tax expenditure analysis, the reason is not one that they can

forthrightly acknowledge.

To my mind, though it is ultimately a matter of contestable political judgment,

advancing this purpose by making tax expenditure analysis more broadly acceptable (as

well as more genuinely informative) is well worth the sacrifice of its currently tighter link

to a Haig-Simons tax reform agenda. Even if we assume that such an agenda is the

proper one in tax policy, its advancement in this manner has simply proved too question-

begging. It seems clear, in retrospect, that Surrey over-reached, but retrenchment is still




The Treasury Discussion is worth addressing here both because it is a significant

document in its own right, and to flesh out this paper’s suggested approach to tax

expenditure analysis. While I try to avoid excessive detail in the critique, it delves a bit

more intimately into details of the United States income tax than some readers may want

to go. Any such readers may prefer to skip ahead to subsection C, which offers a

proposed structure for U.S. tax expenditure analysis.

A. Significance of the Treasury Discussion

The Treasury Discussion starts by accepting the basic idea behind tax expenditure

analysis, that some existing tax provisions seem to reflect a very different enterprise than

equitably raising revenue, and by noting the arbitrariness of the “normative income tax”

baseline that official estimates have always used. It then proposes three main changes:

redefining the baseline income tax to come closer to the Haig-Simons ideal, identifying

negative tax expenditures as well as positive ones, and preparing estimates under a

consumption tax baseline as well as an income tax baseline. A fourth change, evident in

the analysis thought not listed at the front, is greater appreciation of ambiguity, through

the creation of categories for items that are “possibly” or “probably not” tax expenditures

from a given baseline, or the status of which is uncertain.

The use of a consumption tax baseline may ensure a hostile reception of the

Treasury Discussion in some circles. The problem is not just that income tax advocates

are reluctant to give ground, but that the Bush Administration’s general tax policy stance

has raised partisan hackles. Beyond advocating massive tax cuts that can only be

rationalized as surreptitiously “starving the beast,” and seeking major reductions in

progressivity, the Administration is viewed by many as having in place a blueprint to

shift to consumption taxation.86 This shift, moreover, is viewed as of a piece with its

other tax policy aims, notwithstanding that in principle (even if not in any Bush

Administration plans) a consumption tax can be generally as progressive as an income

tax.87 There will be a tendency, therefore, to apply principles of guilt by association and

dismiss the Treasury Discussion as just another exercise in radically reshaping tax policy,

to be opposed by anyone who does not share the Administration’s political goals.

Applying that view here would be a mistake, however. As I argued in section III,

it is difficult to argue persuasively against using a consumption tax baseline as well as an

income tax baseline in tax expenditure analysis, since both systems are plausible and both

are reflected to some extent in the system we have. The question is whether we should

have more information that is reasonably meaningful rather than less, and whether tax

expenditure analysis can be rescued from its current status as the perceived tool of big

government liberals. Moreover, serious work by the Treasury’s professional staff should

not be rejected simply out of dislike for agendas emanating from the top, even if we can

see that those agendas provide an additional motivation for wanting tax expenditure

analysis to be diversified. Anyone who doubts the fair-mindedness of the exercise should

keep in mind that the Treasury Discussion suggests a comprehensive income tax baseline

that is far closer than the existing one to Haig-Simons income, in addition to outlining a

consumption tax baseline.

See, e.g., Robert J. Wells, Wage Slaves Beware – You May Soon Be Financing the
Federal Government, 98 Tax Notes 1029 (February 17, 2003).
See Daniel N. Shaviro, Replacing the Income Tax With a Progressive Consumption
Tax (2003).

The Treasury Discussion groups tax expenditures under existing practice, along

with those that might newly be estimated, into a number of different categories. In the

next two subsections, I first review the Treasury Discussion’s categories, with comments

on some of the more significant items, and then offer suggestions for modifying the

structure of the proposed analysis.

B. Overview of the Treasury Discussion

1. Tax Expenditures Under a Comprehensive Income Tax – The

Treasury Discussion notes that a number of items that are treated as tax expenditures

under current practice would continue to be so under a comprehensive income tax.

Representative examples include the exclusion for municipal bond interest, the deferral of

income from controlled foreign corporations, and the difference between accelerated

depreciation and an assumed measure of economic depreciation.88 The list, being limited

to items that are considered uncontroversial, includes no major surprises. Perhaps of

interest, however, is the fact that the items in this category account for less than half of

the estimated revenue loss for 2004 for all of the items that are currently listed as tax


2. Possibly a Tax Expenditure Under a Comprehensive Income Tax,

But With Some Qualifications – The more noteworthy items in this category include the


a. Deductibility of certain “nonbusiness” state and local taxes,

such as income taxes – The Treasury Discussion notes that, in a comprehensive income

The Treasury Discussion notes that some of these items, such as accelerated
depreciation, are measured differently under its comprehensive income tax baseline than
under the existing “normal income tax” baseline. [Cite.]

measure, the imputed value of state and local government benefits would be included in

income, but state and local taxes would be deducted. Calling allowance of the deductions

a tax expenditure therefore rests on the view that disallowing them would be a good

enough proxy for directly including the value of the benefits. As we will see further

below, this proxy disallowance issue arises repeatedly and ought perhaps to be handled

somewhat differently.

b. Tax-free step-up in basis of capital assets at death – The status

of this provision under a comprehensive income tax ostensibly is ambiguous because,

under such a system, “all gains would be taxed as accrued, so there would be no deferred

unrealized gains on assets held at death.”89 This is true enough, but the response of

classifying it as “possibly” a tax expenditure is unnecessarily confusing. Unlike state and

local income taxes, which would be properly deductible from a comprehensive income

tax standpoint if there were absolutely no correlation between taxes paid and benefits

received, the point here is simply that the gain should have been taxed even sooner. If

the Treasury Discussion distinguished structural from other departures from the

comprehensive income tax baseline, as I suggest below, this item could be moved to the

clear tax expenditure category with a cross-reference to the “structural” section, noting

that it would disappear if current accrual taxation for all assets were adopted.

c. Child tax credit – The allowance of a tax credit, under certain

circumstances, with respect to one’s dependent children is possibly a tax expenditure, the

Treasury Discussion states, “[t]o the extent that the personal and dependent care

exemptions and the standard deduction [which are not listed as tax expenditures] properly

Treasury Discussion at 131.

remove from taxable income all expenditures that do not yield consumption value.”90

The status of the child credits is not clearcut, however, because, under an opposing view,

they are “appropriate modifications that account for different taxpaying capacity,”

The analysis here strikes me as somewhat off the mark. Are the costs of raising a

child, which personal exemptions and the standard deduction may very minimally help to

defray, “expenditures that do not yield consumption value”? I can personally testify to

my consumption preference for feeding my children as compared to not feeding them,

and I am strongly under the impression that they share this preference.91 It also is pure

formalism to distinguish between the above items and child credits on this ground, when

none of the items bears any particular relationship to the expenditures supposedly not

constituting consumption.

The supposedly countervailing point, that child tax credits might be appropriate

adjustments for household-based differences in taxpaying capacity, is where the entire

issue in fact lies. While plainly it is reasonable to adjust for household status in some

way, not everyone would agree with this adjustment – or, indeed, with any of the others

in the current U.S. income tax. My suggestion, as I discuss further below, is to do either

a bit more or a bit less with household adjustments generally.

d. Earned income tax credit – Low-income workers receive a

wage subsidy under certain circumstances that is administered through the income tax via

Id. at 132.
Perhaps the underlying view is that “necessities” do not constitute consumption. This
plainly is mistaken, if we think of consumption as an input to measuring wellbeing,
unless we think that people who fail to get the necessities are no worse off than those
who do get them. The real point, presumably, is that we want to assure that people can
afford necessities before we start taxing them. This is better viewed as a rate bracket
point than a point about what constitutes consumption.

a refundable credit.92 The Treasury Discussion mystifyingly groups this with the child

credit, perhaps on the ground that it is household-related since taxpayers with up to two

dependent children get significantly larger wage subsidies. I would argue that the earned

income tax credit does not belong in the tax expenditure tables to begin with, since it is

simply a part of the overall rate structure, although its household-related aspects could be

covered in connection with household adjustments generally.

3. Uncertain Status as a Tax Expenditure – The items listed here,

relating to medical expenses and charitable contributions, apparently are distinguished

from those that are “possibly” tax expenditures on the ground that their status is

fundamentally contested or ambiguous, rather than requiring adjustment. However one

personally views medical expenses and charitable contributions (and I find arguments

that the latter are not part of consumption to be extremely weak),93 their contested status

supports keeping them out of the “clear” category, on the ground that it is unwise to try to

dictate here.

4. Probably Not a Tax Expenditure Under a Comprehensive Income

Tax – The two main items here are the deductibility of mortgage interest and of state and

local property taxes on owner-occupied homes. The Treasury Discussion notes that,

under a comprehensive income tax, these items would be deducted and the implicit rental

Note how EITC relates to marital status and # of children.
The Treasury Discussion, supra at 132, notes that “charitable contributions could
represent a transfer of purchasing power from the giver to the receiver,” thus reducing the
giver’s net worth. This misses the point that a voluntary giver evidently preferred them
to outlays (also reducing net worth) that everyone agrees are consumption. This is not to
say that charitable deductions are inappropriate, but only that they cannot reasonably be
viewed as leaving the giver worse-off. Medical expenses are more ambiguous because,
even if they improve wellbeing given one’s underlying medical condition, they may be
evidence of worse health status that is relevant to wellbeing. Cite Kaplow on the
insurance issues.

income earned on the housing included.94 This is identical to the point made with respect

to other state and local nonbusiness taxes, a point that the Treasury Discussion does not

directly acknowledge. It states, however, that they are “extremely crude proxies for the

implicit rental income earned on owner-occupied housing. The interest deduction proxy,

for example, ignores implicit rental income earned on a house that is unencumbered by

any mortgage.”95

This fails to establish that the proxies for implicit rental income are cruder overall

than taxes as a proxy for state and local government benefits. The claim that the proxy

here is too crude may relate to the Treasury’s revenue estimates, which estimate the 2004

revenue impact of these two homeowner deductions at $90.6 billion, as compared to a

2004 revenue loss of only $20.5 billion for excluding the implicit rent. With all due

respect to the Treasury’s revenue estimators, however, these estimates are almost certain

to be wildly off the mark.

Is it really plausible that homeowners are running such immense negative

arbitrages on their homes? Suppose we even restrict the comparison to that between the

$20.5 billion estimate for excluding implicit rent and the estimated $68.4 billion revenue

impact for home mortgage interest deductions. Even if all homes are 100 percent

leveraged (suggesting that the issue of homes unencumbered by debt is too trivial to

worry about), this implies that people are paying interest that is more than 330 percent of

the implicit return they are earning on the asset. This could only happen in the very short

run, if home prices suddenly plummeted and the market had not yet adjusted, but even in

that scenario it would leave a wake of distress (such as defaults and foreclosures) beyond

Treasury Discussion at 133.

anything that has recently been observed in the U.S. housing and credit markets.

Accordingly, both these estimates and the Treasury’s conclusion that the mortgage

interest and real property tax deductions are probably not tax expenditures need

reconsideration. As I further discuss below, these items could be grouped with a broader

category of what I call “proxy” disallowance rules in the current tax system.

5. Negative Tax Expenditures – The Treasury Discussion’s treatment

of these items is relatively speculative and preliminary, but the main items mentioned

include the following:

a. Double corporate taxation – The only actual negative tax

expenditure estimate in the Treasury Discussion is for shareholder-level (whether

individual or corporate) taxes on dividends plus shareholder “capital gains realized on

earnings that have been taxed at the corporate level.”96 The estimated revenue gain from

the negative expenditure, based on assuming the continuation of pre-2003 law, was $25.3

billion in 2004, rising to $33.1 billion by 2008.

b. Various loss disallowance rules – The Treasury Discussion

notes that various loss disallowance rules in the U.S. income tax, such as those for

passive losses (pertaining to suspected tax shelters) and net capital losses, depart from

accurate Haig-Simons measurement. It fails to make the point, however, that the loss

disallowance rules generally aim to improve the accuracy of income measurement by

crudely adjusting for suspected mismeasurements made possible by the realization

requirement. They therefore raise proxy disallowance issues and should not be treated as

negative tax expenditures without acknowledgement of or adjustment for this point.

Treasury Discussion at 139.

c. Consumer interest – The Treasury Discussion notes that the

disallowance of deductions for consumer interest is inconsistent with the inter-temporal

approach of income taxation, under which interest expense from dissaving should

seemingly be allowed, symmetrically with including interest income from saving.

d. Lack of inflation indexing – As the Treasury Discussion notes,

this can be viewed as a negative tax expenditure to the extent that it would increase asset

basis and depreciation deductions while reducing interest inclusions, albeit a positive tax

expenditure to the extent that it would reduce interest deductions.

e. Treatment of human capital – Under a Haig-Simons approach,

the Treasury Discussion notes, various education expenses should be amortized and

allowed over the period when they are generating income, rather than being disallowed

(on the premise that they are entirely consumption expenses) as they are, for the most

part, under present U.S. law. This is correct as far as it goes, although one would have to

try to distinguish, for purposes of the estimates, between the investment and consumption

aspects of educational expenditure. The Treasury Discussion fails, however, to mention a

further respect in which the current treatment of educational investment is arguably

preferential. When people forego current work in order to increase their future earnings

potential through education, one could argue for including the imputed return in current

income and then amortizing it along with educational outlays. To be sure, treating this as

a positive tax expenditure would raise the question of just how broadly tax expenditure

analysis should apply to foregone earnings. A comprehensive income tax baseline does

little to illuminate this question, since it offers no clear basis for specifying when we

should treat implicit transactions as equivalent to observable market transactions.97

However, the absence of a positive tax expenditure for this item could raise proxy

taxation issues about the negative tax expenditure with regard to educational outlays.

6. Possible Future Additions to Tax Expenditure Estimates – The

only new items for which the Treasury Discussion includes estimates are homeowners’

imputed rent and corporate double taxation. Among the various items that the Discussion

says might be added in the future are the deferral of unrealized gain and loss, the

exclusion of gifts received, and the allowance of foreign tax credits rather than just

deductions. The rationale for the gift and foreign tax items is that the suggested baseline

treatment might be more consistent with a comprehensive income tax approach, even if

one were to conclude that the Musgravean distribution branch should or might follow the

existing rules.

7. Tax Expenditures Under a Consumption Tax Baseline – There are

no particular surprises in the coverage of a consumption tax baseline. As the Treasury

Discussion notes, full use of this baseline would add to the need for a set of negative tax

expenditure estimates, since all provisions in current law that follow an income tax

approach to saving would have to be so reported.

C. Suggestions for Modifying the Classifications in the Treasury Discussion

The Treasury Discussion is only meant to be preliminary. Thus, in addition to

leaving various issues unresolved, it does not discuss how the nuanced and varied

categories described above could be integrated into the existing structure of official tax

expenditure reporting. Among the aspects of that structure that make such integration

See Daniel Shaviro, Endowment and Inequality, in Joseph J. Thorndike and Dennis J.
Ventry (eds.), TAX JUSTICE: THE ONGOING DEBATE 135 (2002).

more difficult are the structure’s being (1) organized by budgetary function, such as

“Transportation” and “Community and regional development,” and (2) extremely lengthy

due to its including a host of relatively small items (such as numerous separate listings

for different uses of tax-exempt municipal bonds). This structure is better suited for the

use of tax expenditure analysis as a tool of budgetary policy than of tax policy.

One way the Treasury could proceed in the future would be to separate out the

budgetary and tax policy functions. For budgetary reporting purposes, the analysis could

largely keep its present form, including the exclusion of structural and negative tax

expenditure items. Change could be limited to clearly identifying (perhaps through the

use of distinct lists) the items that (1) are not tax expenditures from a consumption tax

baseline, and (2) arguably are not tax expenditures even from an income tax baseline.98

For tax policy reporting purposes, items such as all municipal bonds could be

aggregated, and those below a threshold size (say, $1 billion per year) kept off the list.

The remaining items could then be organized into a manageable set of categories,

including in all cases both positive and negative adjustments. While there is no single

right way of organizing the tax policy list, one possibility, which I offer here in the hope

of stimulating further discussion, is the following:

1. Comprehensive Income Tax Baseline

A. Structural departures from the baseline – Items listed here might

include imputed rent, the double corporate tax, the realization requirement, and the lack

of inflation adjustments.

Household adjustments could either be eliminated from the list or else expanded (with
clear identification of their contestable character) to include additional items, such as
personal exemptions.

B. Other clear departures from the baseline

C. Arguable departures, depending on how one defines the baseline –

Items listed here might include medical deductions and exclusions for employer-provided

health insurance, charitable deductions, and the exclusion of gifts received. If household

adjustments were included here, rather than being left out altogether, additional items

(such as personal exemptions) could be included. The current system of household

adjustments could also be compared to such alternative baselines as (1) a pure separate

returns system for couples and (2) a pure income-splitting system for couples.

D. Proxy departures from the baseline that may offset other departures –

Items listed here might include state and local taxes, home mortgage interest deductions,

and various loss disallowance rules.

2. Comprehensive Consumption Tax Baseline

A. Clear departures from the baseline99

B. Arguable departures, depending on how one defines the baseline

C. Proxy departures from the baseline that may offset other departures

A structural departures list like that for the comprehensive income tax might not be
needed here. Consumption taxes typically do not use realization rules or apply double
corporate taxation. Moreover, they do not present the problem of inflation adjustment if
they use expensing for capital outlays and do not require measurement of interest income
and expense.


Tax expenditure analysis is too potentially useful to be rejected on the ground that

no single conceptual model for a tax system has won universal acceptance. Nor does the

ultimate emptiness of the distinction between “taxes” and “spending,” which the analysis

attempts to fix, prevent it from improving information and reducing the tendentiousness

of our fiscal language. At least in the United States, efforts to make tax expenditure

analysis do too much – by serving as an instrument for one particular vision of tax reform

– have unnecessarily undermined its acceptance. By adapting it to use more flexible and

varied measures that clarify its relationship to underlying distributional aims and that take

account of reasonable disagreements as to those aims, we can hope to improve both its

informational content and its general background influence on budgetary and tax policy


The U.S. Treasury’s 2003 discussion of tax expenditure analysis offers an

important opportunity to advance actual U.S. practice in this area. Unfortunately, the

Treasury analysis is at risk of being engulfed in the bitter partisan wrangling that

increasingly surrounds the American tax policy process. Income tax advocates may be

too suspicious of the Bush Administration’s underlying motivations to give the analysis

full and open-minded consideration. However, if the improved methodology to which

the Treasury Discussion helps point the way can nonetheless win broader acceptance, and

even be permanently incorporated into official reporting practice, then at least there will

be one small bright spot as ever-rising deficits and a radically unstable tax law lead

Americans into a darker fiscal future.