Monday, July 27, 2009

Where your tax dollars go?

Thanks to TaxLawyer Peter Pappas for linking the video below.

The video above is an engaging and fun way to start a discussion of where our tax money goes. As the video notes, at the outset, it's an oversimplification. There are also a few caveats we should note--it's based on 2004 federal data, it only covers federal government spending (and the distribution of state & local government spending is quite different.) Also, it can be hard to figure out exactly what category to put certain items in. (Should government money that goes to fund medical schools be classified as "education" or "health," to take a simple example.)

Still, as I said, I think the video is a great way to start a conversation about an important subject that makes most people's eyes glaze over.

From a public finance perspective, a very important observation to make is that it does not seem to be counting "tax expenditures" when figuring out how much the government is spending on different categories. This turns out to be very important if we are trying to figure out the government spending priorities.

If the government explicitly subsidizes certain kinds of activities by direct appropriation of grants and subsidies (e.g., Pell grants, subsidized student loans, Medicare, Medicaid, etc.) then the video apparently counts those when computing the percentage of government spending on education and health.

But if the government subsidizes those same activities IMPLICITLY and INDIRECTLY through the tax system (e.g., by allowing deductions, credits, or exclusions from taxable income), then the video apparently is not counting those expenditures when computing the percentage of government spending on education and health.

Put a different way: if the government gives a $2,000 cash grant to Sally Student to help her pay for college, then it gets counted as "government spending on education." If the government decides to give that same $2,000 to Sally Student in the form of a tax credit, then it does NOT get counted as government spending, as far as the video is concerned.

The video's methodology is a pretty standard one. Public finance textbooks also employ the same methodology--BUT with an important caveat about the tax expenditure issue, which I'll talk a lot about in my public finance class.

As the Tax Policy Center points out, there has been a growing trend over the past decade for the government to use implicit "tax expenditures" to deliver subsidies to education, via the Hope Credit, Lifetime Learning credit, the tuition tax deduction, 529 Savings Plans, Coverdell plans, and a plethora of other provisions built into the tax code.

Adding up all the tax subsidies for higher education in the most recent Joint Committee on Taxation report to Congress, we get a total of about $20 billion in tax breaks for education in 2008. None of that is included in the usual pie charts showing how much the government spends on education.

Similarly, in the health arena, the government "spends" a lot implicitly via tax expenditures that doesn't get counted in computing the percentage of government spending on health. (The recently infamous gold-plated health plans of the Goldman Sachs top executives are a visible example of this subsidy, but in fact, virtually all members of the middle class fortunate enough to have employer-provided benefits get a significant implicit tax subsidy, compared to other taxpayers whose employers do not provide such benefits.)

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