Reforming the Tax Code: A Path to Fiscal Responsibility and Economic Growth

As policymakers evaluate options for reforming the U.S. tax system, one significant source of potential revenue lies in cleaning up the tax code. The American Institute for Tax Policy and Research (AITPR) estimates that eliminating or restructuring tax expenditures—many of which function as hidden spending programs—could generate trillions in savings. While tax expenditures serve various purposes, they also contribute to budget deficits, distort economic incentives, and complicate tax compliance. Reforming these provisions could pave the way for a more efficient and equitable tax system.

The Hidden Cost of Tax Expenditures

The U.S. tax code is filled with special deductions, exemptions, and credits that reduce federal tax revenue. According to the Treasury Department, there are 170 different tax expenditures that collectively lower federal tax collections by over $28 trillion over the next decade. The Joint Committee on Taxation estimates that income tax-related expenditures alone will cost the government roughly $11 trillion from 2024 to 2028.

While tax expenditures can serve policy objectives, many function as "spending through the tax code"—providing subsidies without the oversight or scrutiny typically applied to direct government spending. Some of the largest tax expenditures include:

• Employer-Sponsored Health Insurance Exclusion ($5.9 trillion, 2025-2034) – One of the most significant and growing tax breaks, this exclusion encourages overinvestment in employer-provided health insurance while distorting labor compensation structures.

• Refundable Tax Credits ($3.6 trillion) – Includes credits such as the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC), which function as direct transfers rather than tax reductions.

• State and Local Tax (SALT) Deduction ($1.5 trillion) – Benefits high-income taxpayers in states with high taxes while reducing federal revenue.

• Mortgage Interest Deduction ($904 billion) – Encourages debt accumulation and inflates home prices, disproportionately benefiting higher-income homeowners.

Green Energy Credits: A Growing Fiscal Challenge

Mortgage Interest Deduction ($904 billion) – Encourages debt accumulation and inflates home prices, disproportionately benefiting higher-income homeowners.

The Inflation Reduction Act (IRA) of 2022 expanded a series of green energy tax credits, significantly increasing their fiscal impact. Treasury estimates that refundable green energy credits will add about $1.2 trillion to the deficit between 2025 and 2034, with major components including:

• Energy Production Tax Credit ($304 billion)

• Clean Vehicle Tax Credits ($206 billion)

• Advanced Manufacturing Production Credit ($190 billion)

Unlike traditional business tax incentives, many of these credits are transferable and accessible to tax-exempt entities, allowing nonprofits and government agencies to claim direct payments. This raises concerns about oversight and efficiency in their allocation. Rolling back or capping these credits could significantly reduce deficit spending.

Reevaluating Refundable Tax Credits

Beyond green energy provisions, several other refundable tax credits contribute significantly to federal outlays:

• Affordable Care Act (ACA) Premium Tax Credit ($1 trillion) – Expanded by the IRA and American Rescue Plan, its cost will decline slightly after 2025 unless extended.

• Earned Income Tax Credit (EITC) ($822 billion) – Provides income support but is susceptible to improper payments due to complex eligibility rules.

• Child Tax Credit (CTC) ($499 billion) – The cost of the CTC will drop substantially after the TCJA’s provisions expire unless extended.

While these credits serve social objectives, they represent substantial spending commitments. Policymakers could consider reforms such as means-testing or adjusting refundability thresholds to improve targeting and reduce fiscal impact.

Business Tax Preferences: Special Treatment for Select Industries

The corporate tax code includes numerous industry-specific carveouts that create market distortions and erode the tax base. Notable examples include:

• Low-Income Housing Tax Credit ($167 billion, 2025–2034) – Intended to incentivize affordable housing construction but has been criticized for inefficiency and high administrative costs.

• Credit Union Tax Exemption ($32 billion) – Provides an unfair advantage to credit unions over taxable financial institutions.

• New Markets Tax Credit ($8 billion) – Targets investment in distressed areas but has limited evidence of broad economic benefits.

• Special Tax Benefits for Blue Cross/Blue Shield ($6 billion) – A legacy provision that distorts competition in the insurance market.

Reducing or eliminating these preferences could contribute to revenue-neutral tax reform, allowing for lower statutory tax rates or deficit reduction.

A Smarter Approach to Tax Reform

By addressing inefficient tax expenditures, lawmakers could raise substantial revenue while simplifying the tax system and improving economic incentives. The challenge is distinguishing between provisions that serve legitimate economic functions—such as neutral treatment of saving and investment—and those that simply redistribute resources without sufficient justification.

Key principles for reform include:

1. Eliminating Tax Expenditures That Function as Spending Programs – Reducing subsidies disguised as tax breaks, particularly refundable credits and industry-specific carveouts.

2. Limiting Distortionary Preferences – Phasing out provisions that encourage inefficient behavior, such as excessive employer-sponsored health benefits or mortgage interest deductions.

3. Enhancing Transparency and Oversight – Ensuring that tax expenditures undergo the same level of budgetary scrutiny as direct government spending.

Cleaning up the tax code could generate trillions in revenue while enabling more sustainable tax policy decisions. Instead of temporary tax cuts that exacerbate deficits, a well-designed reform package could provide long-term fiscal stability and economic growth.