Corporate Tax Expenditures: Information on Estimated Revenue Losses and Related Federal Spending Programs
Released: 2013-04-15T00:00:00

Letter

Background

Corporate tax expenditures are special tax provisions that are exceptions to the normal structure of the corporate income tax system. They represent revenue the federal government forgoes from these tax provisions. The Congressional Budget and Impoundment Control Act of 1974 identified six types of tax provisions that are considered tax expenditures when they are exceptions to the normal tax structure, including exemptions, exclusions, deductions, credits, deferral, and preferential tax rates.

Treasury and the Joint Committee on Taxation each compile an annual list of tax expenditures by budget function with estimates of the corporate and individual income tax revenue losses for each tax expenditure in their respective lists. Treasury and the Joint Committee on Taxation calculate separately the estimated revenue losses for each tax expenditure under the assumptions that all other tax expenditures remain in the tax code and taxpayer behavior remains constant. Thus, the estimated revenue losses do not represent the amount of revenue that would be gained if a particular tax expenditure was repealed, since repeal would probably change taxpayer behavior in some way that would affect revenue.

Corporate income tax expenditures are estimated for firms organized under the tax code as C corporations, which include most large, publicly held corporations, and have their profits taxed at the entity level under the corporate income tax system (filed on an IRS form 1120). Other types of businesses, such as partnerships and S corporations, are referred to as “pass-through” entities because for tax purposes the income earned by these businesses is attributed to or passed through to the owners of the business and are in general taxed only once under the individual income tax system. Treasury and the Joint Committee on Taxation classify the estimated amounts of tax expenditures claimed (or used) by “pass- through” entities as individual income tax expenditures.

The classification of a tax expenditure as corporate or individual, or both is based on the entity that claims or uses the particular tax provision or would report a type of income if it were not excluded from tax. This classification reflects what is referred to as the statutory incidence of the tax expenditure and shows which entities—corporations or individuals, or both—can directly reduce their tax liability because of the tax expenditure. However, as both Treasury and the Joint Committee on Taxation note, the benefits and outcomes from the tax expenditure may be intended to ultimately benefit people other than the direct recipients of the tax expenditure. To the extent that a tax expenditure leads to changes in the prices of particular goods or services, wages, or returns on investment, consumers, employees, or shareholders may see benefits that they otherwise would not have received. A classification based on ultimate beneficiaries would reflect what is known about the economic incidence of tax expenditures rather than the statutory incidence. credit for low-income housing investments, while claimed largely by corporate taxpayers, is intended to ultimately benefit individuals by stimulating the production of affordable rental housing and thereby enabling low-income households to obtain potentially higher quality housing for lower rent than they would have otherwise.

See Tax Policy Center, How Big Are Total Individual Income Tax Expenditures, and Who Benefits from Them? Discussion Paper No. 31 (December 2008) and GAO, Understanding the Tax Reform Debate: Background, Criteria, & Questions, GAO-05-1009SP (Washington, D.C.: Sept. 1, 2005). million in tax year 2007 and 2.2 million in tax year 2000. Measured relative to the economy as a share of gross domestic product (GDP), corporate income tax receipts increased in the years leading up to the economic recession that began in December 2007. During this period they increased from 2.1 percent of GDP in 2000 to 2.7 percent of GDP in 2007 and have since decreased to 1.2 percent of GDP in 2011.

Both members of Congress and the administration have outlined potential frameworks and proposals for modifying and simplifying the corporate income tax system in recent years. A number of these proposals have involved modifying or repealing some corporate tax expenditures to broaden the corporate income tax base and using the resulting revenue offset to reduce corporate income tax rates. One notable challenge for broader corporate tax reform is the degree to which changes to tax expenditures affect other types of taxpayers claiming them as most corporate tax expenditures are also available to other types of business entities other than corporations.

In selecting activities to fund federal policy goals, Congress can choose to enact a tax expenditure rather than a spending program or vice versa for a variety of reasons. We have developed and highlighted criteria and questions for evaluating tax expenditures, including whether other policy tools, such as spending programs, are preferable to tax expenditures. In addition, we have long reported that, once enacted, tax expenditures and their relative contributions toward achieving federal missions and goals are often less visible than spending programs, which are subject to a more systematic review of performance, including results. More recently, the Government Performance and Results Act (GPRA)

Modernization Act of 2010 (GPRAMA) established a framework for providing a more crosscutting and integrated approach to focusing on results and improving government performance, including for tax expenditures. GPRAMA makes clear that the Office of Management and Budget, in coordination with federal agencies, is to identify, among other things, the various federal agencies, program activities, and tax expenditures that contribute to the federal government’s performance plan that defines the level of performance to be achieved toward crosscutting priority goals. These crosscutting priority goals cover a limited number of policy areas as well as goals to improve management across the federal government. Moving forward, GPRAMA implementation can help inform tough choices in setting priorities as policymakers address the rapidly building fiscal pressures facing our national government.

Estimated Revenue Losses from Corporate Tax Expenditures and the Number of Corporate Tax Expenditures Have Increased Since 1986

Estimated revenue losses from corporate tax expenditures have increased over the last few decades in constant dollars, as shown in figure 1. After decreasing in the years following the Tax Reform Act of 1986, due to changes to both tax rates and tax expenditures, corporate revenue losses increased thereafter. Individual revenue losses also increased, although at a faster pace than corporate revenue losses.

From 1986 through 2011, the number of tax expenditures with estimated corporate revenue losses increased from 61 in 1986 to 80 in 2011, as shown in figure 2.

More Than Two- Thirds of Corporate Tax Expenditures Are Also Used by Individuals

Estimated corporate revenue losses in 2011, which totaled $181.4 billion, were approximately the same size as the amount of corporate income tax revenue the federal government collected that year. Individual tax revenue losses totaled $891 billion in 2011, and included tax expenditures used by other types of business entities that pass through to individual taxpayers. According to Treasury’s 2011 estimates, 80 tax expenditures had corporate revenue losses. Of those, two expenditures accounted for 65 percent of all estimated corporate revenues losses in 2011 while another five tax expenditures—each with at least $5 billion or more in estimated revenue loss for 2011—accounted for an additional 21 percent of corporate revenue loss estimates. Table 1 shows the seven largest corporate tax expenditures in 2011.

A majority of corporate tax expenditures are not isolated to the corporate income tax system but also apply to other types of businesses, including “pass-through” entities. Of the 80 tax expenditures used by corporations, 56 were also used by individuals, as shown in figure 3. Modifying any of these 56 tax expenditures as part of broader corporate tax reform would likely affect both corporate and individual taxpayers to some degree. However, the percentage of corporate taxpayers using these tax expenditures varies considerably across the 56 tax expenditures. For example, some tax expenditures are predominately used by corporations, such as the alcohol fuels credit, with estimated corporate revenue losses comprising 96 percent of the tax expenditure’s estimated $500 million income tax revenue loss in 2011.individuals, such as the exclusion of utility conservation subsidies, where corporations account for less than 5 percent of the $220 million estimated revenue loss in 2011. See appendix II for more information on these 56 tax expenditures’ estimated corporate revenue losses in 2011.

Corporate Tax Expenditures Span Many Budget Functions; One-Third of Corporate-Only Tax Expenditures Share a Similar Purpose with Federal Spending Programs

Corporate Tax Expenditures Span Many Budget Functions, and Estimated Corporate Revenue Losses Are Concentrated in Two Budget Functions

Corporate tax expenditures span a majority of federal mission areas, but their relative size differs across budget functions. The 80 corporate tax expenditures had estimated revenue losses in 12 of the 18 budget functions in 2011, as shown in table 2. Of the $181 billion in estimated corporate tax revenue losses, 81 percent was concentrated in the international affairs and housing and commerce budget functions. In these two budget functions, estimated corporate revenue losses were more than federal outlays.

Corporate-only tax expenditures generally support or encourage a specific type of entity or activity. See appendix V for the reported purposes for the 24 corporate-only tax expenditures that were the basis for our identification of related federal activities. Some of these tax expenditures have multiple reported purposes that are broader and in pursuit of national priorities. For example, seven corporate-only tax expenditures are aimed at encouraging or supporting the production of specific energy sources or the development of technology or infrastructure for certain energy sectors. These tax expenditures also have broader purposes such as promoting domestic energy production and energy security.

Other corporate-only tax expenditures provide support for certain types of entities, such as insurance companies or credit unions. Beyond providing support for these entities, these corporate-only tax expenditures may have additional purposes, which are different or broader in scope, related to why these types of entities receive tax support. However some of these tax expenditures were granted to entities prior to World War II and the rationale for continuing support to these entities may have changed over time, making it difficult to determine the purpose of providing the support. Our previous work highlighted the changing historical basis for one of these tax expenditures—the tax exemption of credit union income—as shown in figure 4.

Of the 24 corporate-only tax expenditures, one-third appear to share a similar purpose with federal spending programs. The largest number of these tax expenditures support purposes related to energy- and natural resources and environment-related purposes. These tax expenditures can be broken into two groups: (1) those aimed at encouraging fossil fuel production and development, and (2) those that are intended to encourage technology development, renewable energy, or energy efficiency. We identified related spending programs that appear to share a similar reported purpose with tax expenditures for the second category, but none for the first. See appendix VI for a summary list of related federal spending programs and activities.

While we identified related federal spending programs based on reported purposes specific to the entity or activity being supported, a number of these tax expenditures may also have one or more reported purposes that pursue broader or different aims. If a broader reported purpose was used, the extent of related spending programs identified may change considerably. For example, the bio-diesel and small agri-biodiesel producer tax credits, one of the corporate-only tax expenditures in 2011, have a specific reported purpose of encouraging production of biodiesel fuels, and we identified three federal spending programs that appear to share a similar purpose. Using a broader purpose for this tax expenditure would likely increase the number of federal spending programs identified that have a similar purpose. For example, our prior work on renewable energy identified nearly 700 federal initiatives related to renewable energy, including the bio-diesel and small agri-biodiesel producer tax credits. Applying an even broader national purpose, such as encouraging domestic energy production, could further increase the number of federal spending programs, as well as other federal activities, such as federal regulations and tax expenditures, which may share a similar purpose. Alternatively, applying a different purpose, such as supporting rural and farm areas, could lead to identifying different federal programs that may share a similar purpose.

Agency Comments and Our Evaluation

We provided a draft of this report to the Secretary of the Treasury and the Acting Commissioner of Internal Revenue for comment. Treasury provided technical comments which we incorporated; IRS had no comments on the report.

As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to interested congressional committees, the Secretary of the Treasury, the Acting Commissioner of Internal Revenue, and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov.

If you have any questions on this report, please contact me at (202) 512- 9110 or whitej@gao.gov. Contact points for our offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix VII.

Appendix I: Objectives, Scope, and Methodology

This report: (1) describes trends in the number of corporate tax expenditures and aggregate corporate revenue losses since 1986; (2) describes the use of corporate tax expenditures in 2011; and (3) compares the size of corporate tax expenditures to federal spending by budget function and, for tax expenditures used only by corporations, identifies spending programs with similar purposes.

Trend Analysis of Treasury Tax Expenditure Estimates

To identify how corporate tax expenditures have changed in terms of their numbers and aggregate estimated revenue losses, we analyzed tax expenditure estimates developed by the Department of the Treasury (Treasury) and reported by the Office of Management and Budget in the Federal Budget’s Analytical Perspectives for fiscal years 1986 through 2011. For this period, we determined which tax expenditures had estimates only for corporations, for both corporations and individuals, and only for individuals. We then summed the estimated revenue losses and the number of tax expenditures by taxpayer group to determine changes over time in trend data and to see how the amounts differed between these taxpayer groups.2011 constant dollars to adjust for inflation using the chain price indexes reported in the fiscal year 2013 federal budget. While sufficiently reliable as a gauge of general magnitude, summing revenue loss estimates does not take into account any interactions between tax expenditures. In addition, revenue loss estimates do not incorporate any behavioral We converted all sums for each fiscal year into responses and, thus, do not represent the revenue amount that would be gained if a specific tax expenditure was repealed.

Fiscal Year 2011 Analysis of Treasury Tax Expenditure Estimates and Internal Revenue Service Data on Number of Recipients

For 2011, we analyzed those tax expenditures with only estimated corporate revenue losses and those with both corporate and individual revenue losses.those that Treasury reported had estimated revenue losses for corporations in 2011; we describe any tax expenditures that Treasury estimated lost only corporate tax revenue as corporate-only tax expenditures. We did not conduct a legal analysis to determine which tax expenditures are available only to corporations.

For this study, we defined corporate tax expenditures as To describe the number of taxpayers claiming corporate-only tax expenditures, we obtained estimates, where available, from the Internal Revenue Service (IRS) Statistics of Income (SOI) 2010 corporate sample on the number of corporate taxpayers claiming each of the corporate-only tax expenditures. These were the most recent estimates available at the time of our work. Data compiled by IRS SOI is based on a stratified, random sample of 63,630 corporate income tax returns for 2010 from corporations that end their corporate year from July 1, 2010, through June 30, 2011. These estimates are subject to sampling errors. Based on the number of sampled returns and the coefficients of variation provided by SOI, we estimate that the upper bound of a 95 percent confidence interval for the estimated total number is less than 830 corporations for the following tax expenditures: alternative fuel production credit, bio-diesel and small agri-biodiesel producer tax credits, credit for energy efficient appliances, employer-provided child care credit, tax credit for orphan drug research, small life insurance company deduction, and Special Blue Cross/Blue Shield deduction. For our report, IRS SOI provided data on C corporations, and we excluded S corporations that pass through to individual taxpayers. C corporations include active corporations filing tax forms 1120, 1120-F, 1120-L, and 1120-PC but not tax forms 1120S, 1120-REIT, and 1120-RIC. Overall, IRS SOI was able to provide estimates for nine tax credits or deductions because these tax expenditures were reported on an isolated line of an IRS form. However, for two of those tax credits, the requirement to protect taxpayer information forced IRS to exclude estimates of the number of tax recipients of those credits.

We also obtained publicly available fiscal year 2010 data from IRS’s Tax Exempt and Government Entities division on four corporate-only tax expenditures. These corporate-only tax expenditures were tax exemptions and included the exemption of credit union income, tax exemption of certain insurance companies owned by tax-exempt organizations, exemption of certain mutuals’ and cooperatives’ income, and special alternative tax on small property and casualty insurance companies. For three of the four tax expenditures that we obtained publicly available data on the number of organizations claiming the tax exemption, the data represented only a portion of organizations to which the exemption applies as reporting requirements differ within each of these tax expenditures. From these two sources, IRS SOI estimates and publicly available data from IRS’s Tax Exempt and Government Entities division, we were able to obtain data on the number of taxpayers claiming 13 of the 24 corporate-only tax expenditures, including credits, deductions, or exemptions. IRS was not able to provide data on the remaining eleven tax expenditures generally because they could not be isolated on an IRS form. To assess the reliability of the data and estimates, we reviewed agency documentation, interviewed agency officials, and reviewed our prior reports that have used the data and estimates. While we determined that the Treasury and IRS data and estimates were sufficiently reliable for our purposes, the IRS SOI corporate sample may not provide a precise estimate of the number of taxpayers claiming a tax expenditure when the number of taxpayers is very small.

Comparison of Estimated Revenue Losses and Federal Outlays and Reported Purpose and Those Federal Activities That Appear to Share a Similar Purpose

To analyze how large corporate tax expenditures are in comparison to federal spending by budget function, we summed the estimated revenue losses for those tax expenditures with corporate revenue losses in fiscal year 2011 by budget function from the fiscal year 2013 Analytical Perspectives. We compared them to federal outlays by budget function in fiscal year 2011, using data from the President’s fiscal year 2013 budget. Outlay-equivalent estimates—the amount of outlays required to deliver the same after-tax income as provided through the tax expenditure—may provide for a more appropriate comparison to federal spending than estimated revenue losses if particular outlays represent taxable income to the recipient. However, Treasury no longer estimates outlay equivalent values for tax expenditures and therefore, estimated revenue losses were used instead.

For this report we identified related programs based on a narrow reported purpose specific to the type of entity or activity that the corporate-only tax expenditures support or target. The corporate-only tax expenditures may have additional broader or different purposes. Using the narrow reported purposes allowed us to identify the tax and nontax programs that appear to most closely support the activity or entity the corporate-only tax expenditures support. We defined the narrow reported purpose as providing support for a certain activity or entity or in some cases, where the materials we reviewed discussed the tax expenditure as intended to encourage or increase a certain activity, we described the reported purpose as encouraging that type of activity. To identify the reported purpose of corporate-only tax expenditures, we reviewed their legislative histories and prior work by GAO, the Congressional Research Service (CRS), including the CRS’s 2010 tax expenditure compendium, and the Congressional Budget Office (CBO) that discussed the intended purpose or rationale of the tax expenditure. However, in identifying the narrow reported purposes we were not trying to discern legislative intent. For some tax expenditures, the reported purpose may be clear from reviewing these sources, while for others the reported purpose may be more difficult to determine. Some tax expenditures support a certain type of entity but the reported purpose or rationale for providing support to that entity is difficult to determine or may have changed over time. Therefore, we describe the reported purpose as support for a type of entity, and we did not reconstruct the historical basis for providing such support.

To identify federal spending programs that appear to share a similar reported purpose, we searched the October 2012 version of the Catalog of Federal Domestic Assistance (CFDA) using terms from the description of the corporate-only tax expenditures. We reviewed programs listed under the same budget functions and reviewed the descriptions of the programs initially identified to determine if they appear to share a similar reported purpose. We identified related tax expenditures by reviewing the fiscal year 2013 Analytical Perspectives, supplemented with the description in CRS’s 2010 tax expenditure compendium.

We obtained data from IRS for the tax expenditures identified as related, from the Department of Energy for the Integrated Biorefineries Program, and for the standards and regulations identified as related from the Department of Energy and the Environmental Protection Agency. our analysis of those data or identification of related programs. After reviewing CFDA documentation, our prior reports that have used the data, and spot checking these three data element against other publicly available agency documentation, we determined the data were reliable for our purposes. In reporting the administering or implementing agencies or entities, we generally reported the federal department level rather than the sub-department level agency except for IRS and the Environmental Protection Agency. In addition, for reporting the type of assistance, we grouped the types of assistance into the following categories: grant, cooperative agreement, direct payment, direct loan, guaranteed loan, insured loan, regulation/standard, tax exclusions, exemptions, or deductions, tax credits, deferrals of tax, and preferential tax rates. In some cases, the CFDA identified the programs we identified as providing multiple types of assistance listed above.

The list of nontax programs we identified that appear to share a similar specific reported purpose has not been reviewed by the agencies responsible for them. Treasury and IRS reviewed our identification of related tax expenditures. The list of tax and nontax programs, shown in appendix VI, does not represent a comprehensive list of related federal activities for several reasons:

The CFDA may not capture certain types of federal activities, such as regulations or standards. Based on our prior work, we were able to identify some regulatory programs which we believe also appear to share a similar reported purpose to the tax expenditures in our scope.

The federal spending programs and activities identified may also have multiple reported purposes, and only a component of the program or activity may appear to specifically share a similar reported purpose to the tax expenditure.

Using a broader or different reported purpose to identify federal activities that appear to share a similar reported purpose would likely alter the makeup of activities that appear to be related.

We conducted our work from October 2012 to March 2013 in accordance with all sections of GAO’s Quality Assurance Framework that are relevant to our objectives. The framework requires that we plan and perform the engagement to obtain sufficient and appropriate evidence to meet our stated objectives and to discuss any limitations in our work. We believe that the information and data obtained, and the analysis conducted, provide a reasonable basis for any findings and conclusions in this product.

Appendix II: Fifty-Six Tax Expenditures with Estimated Corporate and Individual Revenue Losses Reported by Treasury, by Largest Estimated Corporate Revenue Losses, 2011

Tax expenditure

Estimated corporate revenue losses (dollars in millions)

Credit to holders of Gulf Tax Credit Bonds.

Exclusion of utility conservation subsidies Expensing of certain multiperiod production costs Accelerated depreciation on rental housing (20) (40)

Accelerated depreciation of buildings other than rental housing (3,300)

Total

In addition, the alcohol fuel mixture credit results in a reduction in excise tax receipts of $6,520 million in 2011.

In addition, the small business credit provision has outlay effects of $30 million in 2011.

In addition, the provision for school construction bonds has outlay effects of $430 million in 2011.

In addition, the provision has outlay effects of $20 million in 2011.

Appendix III: Twenty-Four Tax Expenditures with Only Estimated Corporate Revenue Losses Reported by Treasury, by Largest Estimated Corporate Revenue Losses, 2011

Total

In addition, the credit for holders of zone academy bonds had outlay effects totaling $10 million in 2011.

In addition, the biodiesel producer tax credit results in a reduction in excise tax receipts of $760 million in 2011.

These figures do not account for the tonnage tax which shipping companies may opt into in lieu of the corporate income tax. The tonnage tax reduces the cost of this tax expenditure by $20 per year in each year of the budget.

Appendix IV: Number of Corporate Taxpayer Recipients for Corporate-Only Tax Expenditures, 2010

Appendix IV: Number of Corporate Taxpayer Recipients for Corporate-Only Tax Expenditures, 2010 Tax expenditure Tax exemption of certain insurance companies owned by tax-exempt organizations Exemption of certain mutuals’ and cooperatives’ income Exemption of credit union income Special alternative tax on small property and casualty insurance companies Bio-diesel and small agri-biodiesel producer tax credits Small life insurance company deduction Tax credit for orphan drug research Special Blue Cross/Blue Shield deduction Credit for energy efficient appliances According to the Internal Revenue Service Statistics of Income division, estimate should be used with caution due to small number sampled returns claiming this credit.

Appendix V: Reported Purpose Supporting a Specific Activity or Entity for 24 Corporate- Only Tax Expenditures

Number Tax expenditure 1

Appendix VI: Federal Activities That Appear to Share a Similar Purpose to 24 Corporate- Only Tax Expenditures

Number Tax expenditure 1

Number Tax expenditure 9

Number Tax expenditure 18

Appendix VII: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact name above, MaryLynn Sergent (Assistant Director), Jason Vassilicos (Analyst-in-Charge), Kevin Daly, Robert Gebhart, Lois Hanshaw, Natalie Maddox, Donna Miller, Karen O’Conor, Mark Ryan, and Elwood D. White all made contributions to this report.