Tax expenditures are a departure from the “normal” tax code that lowers the tax burden of select individuals or businesses through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government.
Even all of these decades later, I still remember one class from my law school years more clearly than most of the others and, from that, one series of lectures more clearly than most of the remainder.
As I recall the name, the class was “Tax I” (effectively, introduction to tax principles). As were many of the classes then (and still) at the University of Virginia, “Tax I” was taught by a former federal government official with recent, hands-on experience with the issues he discussed. In this case, the lecturer was Edwin Cohen, then fresh back to the Law School from stints first as the Assistant Secretary of the Treasury for Tax Policy and subsequently as Under Secretary of the Treasury.
The lectures that I recall so clearly were on “tax expenditures.” The reason I recall them is because they were the first time, at least as I recall, that I realized things weren’t always as they seemed on the surface. As Professor Cohen explained them, “tax expenditures” are tax exemptions, deductions, credits, preferential rates, and similar provisions that really are government spending disguised by running them through the tax code.
By selectively lowering the tax burden for certain types of businesses and activities, he explained they effectively serve as a government subsidy. But because they are done through the tax code, they avoid the annual scrutiny of the appropriations process. As a result, they fly below the public radar, surviving in a way that they might not if they had to be rejustified annually as the spending of taxpayer funds.
I was reminded of what I learned from those lectures several years ago when I started spending an increasing amount of time looking at federal fiscal issues. While I don’t recall if I learned as part of the Law School lectures how large a part of the federal budget “tax expenditures” were at that time, I realized as I dived into the subject again that, in the current age, they are huge.
Like the Alaska budget, the federal budget runs huge annual deficits. In its most recent (May 2023) “Update to the Budget Outlook,” for example, the Congressional Budget Office estimates that the federal “deficit is projected to total $1.5 trillion in 2023 [and] annual deficits are to average $2.0 trillion over the 2024–2033 period.” Over that period, the deficits represent roughly 20 to 25% of annual spending, which is projected to “rise from $6.5 trillion in 2024 to $9.8 trillion in 2033.”
Compared to those, federal tax expenditures totaled $1.7 billion in 2022 and are projected to continue to rise proportionally throughout the same projection period.
Comparing the two numbers, it is clear that reducing, if not eliminating, tax expenditures could make a substantial contribution toward eliminating the projected federal deficits.
While here we call them “indirect expenditures,” on a state level, Alaska also engages in making tax expenditures. As defined by the Legislative Finance Division (LFD), “indirect expenditures are foregone revenue to the State due to tax credits, exemptions, discounts, deductions, and other provisions.” The Department of Revenue (DOR) publishes data on each indirect expenditure every two years. LFD periodically evaluates its effectiveness.
Not unlike at the federal level, the numbers are strikingly large.
This chart compares the size of the tax expenditures to the size of the deficits, calculated as the level of cuts in the Permanent Fund Dividend (PFD) made in the relevant year, from FY2017 through FY2021.
As at the federal level, it is clear, comparing the two numbers, that reducing, if not eliminating, Alaska’s tax expenditures also could make a substantial contribution toward eliminating the state’s projected deficits.
What are Alaska’s “indirect expenditures?” The biennial DOR report compiles them by the agency that administers them. As shown on the following chart, by far the largest portion of the tax subsidies (89%) are administered by DOR itself.
Within DOR, by far the largest share (85%) is the “Per-Taxable-Barrel Credit for Non-GVR-Eligible Production.” Without that particular credit, FY2021 tax expenditures would only have totaled $267 million, or approximately 22% of the FY2021 deficit.
Put another way, reversing that tax expenditure alone would have been sufficient, on average, to offset 88% of the annual budget deficit from FY2017 through FY2021.
As we said earlier, one of the fundamental consequences of creating a tax expenditure is that it “hides” significant governmental spending from the appropriations process. That has two effects: first, it obscures the spending from public view; second, it prevents the spending from being compared transparently on an annual basis against other spending or revenue approaches.
For example, despite effectively being another category of public spending, by being buried in the tax code, the “Per-Taxable-Barrel Credit for Non-GVR-Eligible Production” avoids being compared annually, as has become the case with the PFD, against K-12, the University or other spending. It also avoids being compared annually to other revenue options, such as PFD cuts or other forms of broad-based taxes.
Put differently, it avoids hi-liting the fact that, if included in LFD’s “swoop” graph for FY2021 unrestricted general fund (UGF) spending, tax expenditures overall would have ranked third, only slightly behind spending for K-12 and the then-combined Health & Social Services. Even separated from the other tax expenditures, tax expenditures on the Per-Taxable-Barrel Credit for Non-GVR-Eligible Production alone would still have ranked third.
When looking for places to cut, as with K-12, HSS, the University, and other large spending categories, tax expenditures, and specifically, the Per-Taxable-Barrel Credit for Non-GVR-Eligible Production, would have stood out like a sore thumb.
According to a 2023 report from the federal General Accounting Office (GAO) on “The Nation’s Fiscal Health,” another characteristic of tax expenditures at the federal level is that “it is not always clear how successfully tax expenditures achieve their intended policy goals.” This same characteristic appears to be true also of at least some tax expenditures at the state level.
According to DOR’s latest biennial report, for example, the “Legislative Intent, Public Purpose” of the “Per-Taxable-Barrel Credit for Non-GVR-Eligible Production” is “to provide a direct incentive for oil production.”
When, as part of its 2021 report to the Legislature, LFD reviewed whether the credit was meeting its “legislative purpose,” however, it concluded that the result was “indeterminate.” When responding to the question of whether the expenditure should be “continued, modified or terminated,” LFD recommended “reconsideration.”
As we have discussed in a previous column, when providing a list of revenue options in its 2022 Fiscal Plan Model, DOR suggested that the tax expenditure for the per barrel credit could be reduced substantially without negatively impacting oil production over the next decade. In short, at least to the extent suggested by the DOR model, the tax expenditure was not providing “a direct incentive for oil production.”Despite that, to date, neither the Dunleavy administration nor the Legislature has yet pursued the changes to the per-taxable-barrel credit the Fiscal Plan Model suggested.
As the Committee for a Responsible Federal Budget (CRFB) recently summarized at the federal level, “addressing tax expenditures could raise substantial revenue.”
The same is true at the state level. As we explained in last week’s column, compared to the other revenue options researchers from the University of Alaska-Anchorage’s Institute of Social and Economic Research (ISER) evaluated in their 2016 study, PFD cuts have the “largest adverse impact” on the overall Alaska economy and are “by far the costliest measure for Alaska families.”
Before continuing down that road, both the administration and the Legislature owe it to Alaskans to follow up on both LFD’s 2021 recommendation that at least the Per-Taxable-Barrel Credit for Non-GVR-Eligible Production should be subject to “reconsideration” and the recommendations contained in DOR’s 2022 Fiscal Plan Model for ways that approach could be done.
As Professor Cohen stressed in those long-ago lectures about federal tax expenditures, Alaska shouldn’t continue to allow the form of public spending to obscure periodic consideration of whether, in the then-current contexts, it remains good policy.
Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.