Tax Expenditures: The Hidden Spending in the Tax Code

When people picture government spending, they usually imagine checks being written: a road contract, a school budget, a benefit payment. But governments also spend money in a much quieter way - by simply choosing not to collect it from certain people for certain purposes. Economists call this a tax expenditure: a provision in the tax code that lowers the taxes someone owes, in order to encourage or reward a specific behavior. It never shows up as a line item in the spending budget, but its effect on the government’s finances is identical to writing a check.

Spending through the tax code

A tax expenditure works through one of a few mechanisms. A deduction reduces the amount of income that gets taxed in the first place - the mortgage interest deduction, for example, lets homeowners subtract the interest they paid on a home loan before calculating their tax bill. A tax credit goes a step further, reducing the tax bill itself, dollar for dollar, rather than just the income being taxed. An exclusion removes certain income from taxation entirely, such as the employer contribution toward health insurance, which most workers never pay income tax on at all.

Each of these does the same thing a direct government check would do: it puts more money in someone’s pocket to encourage a particular choice, whether that’s buying a home, having a child, installing solar panels, or saving for retirement. The government could, in theory, tax everyone at a higher flat rate and then mail out checks to homeowners or parents instead - the tax expenditure just achieves the same transfer through the tax return.

Why the size of this surprises people

Tax expenditures add up to an enormous amount of forgone revenue - in the United States, they total well over a trillion dollars a year, comparable to some of the largest categories of direct federal spending, including major entitlement programs. Yet because they never appear as an appropriation that Congress votes on annually, they receive far less scrutiny than direct spending does. A new highway program gets debated, budgeted, and reviewed every year; a decades-old deduction can quietly continue indefinitely without anyone revisiting whether it still makes sense.

This invisibility is part of what makes tax expenditures politically durable. Cutting a spending program requires an active vote to eliminate it. Ending a tax expenditure often gets framed as a “tax increase,” which tends to be far more politically costly, even when the fiscal effect on the government’s bottom line is identical.

Who actually benefits

Because deductions reduce taxable income rather than providing a flat credit, their value often rises with a taxpayer’s income level. A household in a high tax bracket saves more from a dollar of deduction than a household in a low bracket does, since the deduction is worth whatever tax rate applies to that dollar. This means many tax expenditures - the mortgage interest deduction is a frequently cited example - deliver their largest dollar benefits to higher-income households who own more expensive homes and carry larger mortgages, even when the stated goal is to encourage homeownership broadly.

Weighing them like any other spending

Because tax expenditures function as spending, economists generally argue they deserve the same scrutiny as any appropriation: does this provision achieve its stated goal efficiently, who actually benefits, and would the money do more good spent a different way? Some countries now publish an annual “tax expenditure budget” alongside the regular budget, listing each provision’s estimated cost, specifically to make this hidden spending visible and subject to the same debate as everything else the government funds.