oversight

Tax Policy: Factors for Evaluating Expiring Tax Provisions

Published by the Government Accountability Office on 2012-06-08.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            United States Government Accountability Office

GAO                         Testimony
                            Before the Subcommittee on Select
                            Revenue Measures, Committee on Ways
                            and Means, House of Representatives

                            TAX POLICY
For Release on Delivery
Expected at 9:30 a.m. EDT
Friday, June 8, 2012



                            Factors for Evaluating
                            Expiring Tax Provisions
                            Statement of James R. White, Director
                            Strategic Issues




GAO-12-760T
                                              June 8, 2012

                                              TAX POLICY
                                              Factors for Evaluating Expiring Tax Provisions

Highlights of GAO-12-760T, a testimony
before the Subcommittee on Select Revenue
Measures, Committee on Ways and Means,
House of Representatives



Why GAO Did This Study                        What GAO Found
GAO was asked to discuss the                  Factors commonly used to evaluate tax policy, as well as other policy tools such
extension of tax provisions, sometimes        as spending programs or regulations, can be applied to decisions about whether
called tax extenders, that either             and how to extend expiring tax expenditures, as discussed below.
expired in 2011 or are scheduled to
expire at the end of 2012. For a prior        Revenue Effects. Revenues foregone through tax expenditures either reduce
hearing of this subcommittee, the Joint       resources available to fund other federal activities or require higher tax rates to
Committee on Taxation (JCT) prepared          raise a given amount of revenue. Like decisions about spending, deciding
a document detailing 64 expiring tax          whether to extend an expiring tax expenditure involves considering whether the
provisions. Most of these provisions          benefit of the intended outcome is worth the effect on other programs or tax
are tax expenditures—reductions in a          rates. The nation’s long-term fiscal challenge makes it all the more important to
federal taxpayer’s tax liability that         ensure tax expenditures are efficient and relevant.
result from special credits, deductions,
exemptions and exclusions from                Criteria for Good Tax Policy. Three long-standing criteria typically used to
taxation, deferral of tax liability, and      evaluate tax policy—equity; economic efficiency; and a combination of simplicity,
preferential tax rates. Tax expenditures      transparency, and administrability—can be applied to the expiring tax
are often aimed at policy goals similar       expenditures. Because the criteria may sometimes conflict with one another,
to those of spending programs, such           there are usually trade-offs to consider when evaluating particular tax
as encouraging economic development           expenditures.
in disadvantaged areas and stimulating
                                              Relationship to Other Policy Tools. Tax expenditures represent just one policy
research and development. Because
revenue is foregone, these provisions         tool of several—including spending, grants, loans, and regulations—that
may, in effect, be viewed as spending         policymakers can use to achieve policy goals. If not well designed, tax
programs channeled through the tax            expenditures can create the potential for duplication with other policy tools.
system. For those provisions the              Measurement Challenges. Unavailable or insufficient data can hinder
President proposed extending through          policymakers’ ability to consider how the factors described above relate to
2013, JCT estimated the budgetary             particular tax expenditures. A key challenge is that data necessary to assess how
effect would be at least $40 billion in
                                              a tax expenditure is used and by whom generally are not collected on tax returns
foregone revenue over its 10-year
                                              unless the Internal Revenue Service needs the information to ensure tax
budget window.
                                              compliance or is legislatively mandated to collect or report the information.
This testimony outlines factors useful
for considering trade-offs when               GAO’s prior reports on tax expenditures illustrate how these factors can be used
deciding whether and how to extend            to evaluate whether and how to extend expiring tax provisions. For example,
provisions and illustrates their              GAO found that the research tax credit, as currently designed, provides many
application to some of the expiring           recipients with windfall benefits earned for spending they would have done
provisions. GAO’s testimony is based          anyway. A report on domestic ethanol production—in which GAO suggested
on previous work on tax reform and tax        modifying or phasing out a tax credit that was duplicative of the renewable-fuel
expenditures.                                 standard—highlights the importance of considering how tax expenditures relate
                                              to other policy tools. GAO’s work on higher-education tax expenditures illustrates
What GAO Recommends                           how tax expenditures that are not transparent (i.e., cannot be easily understood
GAO has made many                             by taxpayers) can result in taxpayers making decisions that do not maximize their
recommendations in its previous               tax benefits. This work also concluded that little is known about the effectiveness
reports on tax expenditures that reflect      of education-related federal grants, loans, and tax expenditures in promoting
the factors described in this testimony.      certain student outcomes, such as college attendance. Research gaps may be
Some have been acted on, while                due, in part, to data and methodological challenges—such as difficulty isolating
others have not.                              the behavioral effects of the tax expenditure under study from other changes—
                                              that have proven difficult to overcome.
View GAO-12-760T. For more information,
contact James R. White at (202) 512-9110 or
whitej@gao.gov.

                                                                                       United States Government Accountability Office
Chairman Tiberi, Ranking Member Neal, and Members of the
Subcommittee:

I am pleased to be here to discuss the extension of tax provisions,
sometimes called tax extenders, which either expired in 2011 or are
scheduled to expire at the end of 2012. These provisions were the subject
of an April hearing before this subcommittee, for which the Joint
Committee on Taxation (JCT) prepared a document detailing 64 expiring
provisions. 1 Most of the 64 expiring provisions are tax expenditures—
reductions in a federal taxpayer’s tax liability that result from special
credits, deductions, exemptions and exclusions from taxation, deferral of
tax liability, and preferential tax rates. 2 Tax expenditures are provisions
that are exceptions to the “normal structure” of the individual and
corporate income tax. Other provisions that reduce tax liability, such as
many deductions for business expenses, are considered to be part of the
normal tax structure and are not considered tax expenditures. 3

Tax expenditures are often aimed at policy goals similar to those of
spending programs, such as encouraging economic development in
disadvantaged areas, promoting energy efficiency, or stimulating


1
 For the purposes of that hearing, a tax extender was defined as any tax provision
extended in title VII of the Tax Relief, Unemployment Insurance Reauthorization, and Job
Creation Act of 2010, Pub. L. No. 111-312, 124 Stat. 3296 (Dec. 17, 2010), or expiring
between the end of calendar year 2011 and the end of calendar year 2012, other than any
provision addressed in titles I through VI of Pub. L. No. 111-312 or related to a
transportation trust fund. For a list of the 64 expiring provisions, see Joint Committee on
Taxation, Legislative Background of Selected Federal Tax Provisions Scheduled to Expire
in 2011 or 2012, JCX-39-12 (Washington, D.C.: Apr. 25, 2012). Also, the list of 64
provisions does not include (1) individual income tax rate reductions, enacted into law
primarily by the Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No.
107-16, 115 Stat. 38 (June 7, 2001); (2) an increase in the exemption amount under the
Alternative Minimum Tax enacted by the Jobs and Growth Tax Relief Reconciliation Act of
2003, Pub. L. No. 108-27, 117 Stat. 752 (May 28, 2003); (3) a reduction of Social Security
tax rates for employees and self-employed individuals, initially enacted for 2011 by the
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub.
L. No. 111-312, 124 Stat. 3296 (Dec. 17, 2010); or (4) provisions on temporary disaster
relief.
2
 Examples of expiring provisions that are not tax expenditures are those covering the
disclosure of prisoner tax return information to certain prison officials under 26 U.S.C.
6103(k)(10) and refunds disregarded in the administration of federal programs and
federally assisted programs under 26 U.S.C. 6409.
3
 The concept of tax expenditures extends beyond the income tax. Tax expenditures also
exist for other types of taxes, such as excise taxes.




Page 1                                                                           GAO-12-760T
research and development. Because revenue is foregone, these
provisions may, in effect, be viewed as spending programs channeled
through the tax system. JCT’s publication providing revenue estimates for
provisions contained in the President’s fiscal year 2013 budget proposal
does not include all of the 64 expiring provisions. However, for those
provisions the President proposed extending through 2013, JCT
estimated that the budgetary effect would be at least $40 billion in
foregone revenue over its 10-year budget window. 4

Like budget decisions for spending programs, decisions on whether and
how to extend expiring tax provisions involve trade-offs between policy
goals and revenue costs. My testimony today will outline a set of factors
useful for understanding these trade-offs and illustrate their application to
some of the expiring provisions. Although the main focus of my testimony
is on how the factors apply to evaluating expiring tax expenditure
provisions, the factors are also relevant to evaluating other expiring
provisions, such as those related to tax administration. This testimony is
based on previous GAO reports on tax reform and tax expenditures.
Additional information on our scope and methodology is available in those
published products, which are referenced throughout this statement.

The work for this testimony and the reports on tax expenditures upon
which it is based were conducted in accordance with generally accepted
government auditing standards. Those standards require that we plan
and perform the audit to obtain sufficient, appropriate evidence to provide
a reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable
basis for our findings and conclusions based on our audit objectives.




4
 Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions
Contained in the President’s Fiscal Year 2013 Budget Proposal, JCX-27-12 (Washington,
D.C.: Mar. 14, 2012). JCT revenue estimates compare predicted federal revenues under a
proposal with predicted revenues under present law. JCT provides a year-by-year
comparison for a 10-year budget window, which we provide for this and each example
listed below. Negative estimates reflect decreased revenue, and positive estimates reflect
increased revenue. Revenue estimates take certain behavioral responses into account.




Page 2                                                                       GAO-12-760T
                      Factors commonly used to evaluate tax policy in general can be applied
Factors to Consider   to decisions of whether and how to extend expiring tax provisions,
When Evaluating       including tax expenditure provisions. The factors, listed in table 1 and
                      discussed below, may also be relevant to evaluating other policy tools,
Expiring Tax          such as spending programs or regulations. 5
Provisions
                      Table 1: Factors to Consider When Evaluating Expiring Tax Provisions

                       1. Revenue effects
                       2. Criteria for good tax policy
                            Equity
                            Economic efficiency
                            Simplicity, transparency, and administrability
                       3. Relationship to other policy tools
                       4. Measurement challenges
                      Source: GAO.



                      1. Revenue Effects. Tax expenditures may, in effect, be viewed as
                      spending programs channeled through the tax system. Tax expenditures
                      can be viewed this way because they grant special tax relief for certain
                      kinds of behavior by a taxpayer or for taxpayers in special circumstances.
                      Revenues foregone through tax expenditures either reduce funding
                      available for other federal activities or require higher tax rates to raise a
                      given amount of revenue. Like decisions about spending, deciding
                      whether to extend an expiring tax expenditure involves considering
                      whether the benefit of the intended outcome is worth the effect on other
                      programs or tax rates. Revenue the government would have collected
                      absent a tax expenditure could have been used for other federal priorities,
                      deficit reduction, or tax rate reductions.

                      The long-term fiscal challenge facing the United States makes it all the
                      more important to ensure all major federal spending and tax programs
                      and policies—including tax expenditures—are efficient and relevant.
                      Although the expiring tax expenditures being discussed today represent
                      only a portion of all tax expenditures, on the whole, tax expenditures
                      represent a substantial federal commitment. Aggregate revenue losses


                      5
                       These factors have been described in our previous reports. For example, we discuss
                      criteria for good tax policy in GAO, Understanding the Tax Reform Debate: Background,
                      Criteria, & Questions, GAO-05-1009SP (Washington, D.C.: September 2005).




                      Page 3                                                                     GAO-12-760T
were an estimated $1 trillion in fiscal year 2011. 6 For the past three
decades, annual revenue losses from all tax expenditures have been
similar to the amount of discretionary spending each year. As such,
evaluating tax expenditures, including the expiring provisions being
considered today, can help policymakers assess how to alleviate the
rapidly building fiscal pressures facing our national government.

2. Criteria for Good Tax Policy. Three long-standing criteria typically
used to evaluate tax policy—equity; economic efficiency; and a
combination of simplicity, transparency, and administrability—can be
applied to the expiring tax expenditures. 7 The criteria may sometimes
conflict with one another and some are subjective. As a result, there are
usually trade-offs to consider between the criteria when evaluating
particular tax expenditures or other tax provisions.

•   Equity. There is a wide range of opinions regarding the fairness or
    equity of tax provisions. Nevertheless, certain principles, such as a
    taxpayer’s ability to pay taxes and the extent to which a taxpayer
    benefits from a provision, are useful for thinking about equity.
    Similarly, analytical tools, such as distributional analysis, can provide
    information about who pays or benefits that may inform value
    judgments about the equity effects of the expiring tax expenditures.

•   Economic efficiency. The expiring tax provisions generally are
    efforts to redirect society’s resources to achieve a variety of economic
    or social goals. Lightly taxing some activities targeted by the expiring
    provisions shifts resources to them and away from less-tax-favored
    activities. For example, the research tax credit is designed to increase
    the overall level of resources that the private sector invests in
    research, but this comes at the cost of fewer resources devoted to
    other activities. To the extent that a tax provision shifts resources to
    an activity that provides greater economic benefits to society as a
    whole than the private sector would provide on its own, there is a net



6
 Summing revenue loss estimates does not take into account possible interactions
between individual provisions or potential behavioral responses to changes in these
provisions on the part of taxpayers. Additionally, revenue loss estimates include the effect
of certain tax credits on receipts only and not the effect of the credits on outlays. While
revenue estimates do take certain behavioral responses into account, tax expenditure
revenue loss estimates do not.

GAO-05-1009SP.
7




Page 4                                                                         GAO-12-760T
    gain that is said to improve economic efficiency. These gains improve
    peoples’ well-being in a variety of ways, including increased income
    and consumption opportunities.
    Estimating efficiency gains and losses can be challenging. Studies
    may be limited by what can be quantified; for example, studies may
    examine dollars spent on qualified research or the number of
    economic development projects built, rather than whether the use of
    funds for these activities constitute a better use of resources.

•   Simplicity, transparency, and administrability. A tax expenditure’s
    design can affect three related and desirable features of tax
    provisions: simplicity, transparency, and administrability. Simple tax
    expenditures impose less taxpayer compliance burden, such as
    keeping records, learning about tax rules, filing tax returns, and other
    compliance activities. Transparent tax provisions are easy to
    understand, that is, taxpayers can grasp the logic behind them.
    Administrable tax expenditures have lower administrative costs for
    both the Internal Revenue Service (IRS) and third parties, such as
    banks or employers required to submit information on taxpayers’
    income and transactions to IRS. Administration includes processing
    returns, programming information systems, answering taxpayer
    questions, and enforcement activities. Simplicity, transparency, and
    administrability are not the same but are interrelated. For example,
    extensions of expiring tax code provisions, sometimes retroactively,
    can add compliance burden, reduce taxpayers’ understanding of the
    tax laws, and impose additional costs on IRS, such as more phone
    calls from taxpayers. 8
3. Relationship to Other Policy Tools. Tax expenditures are one policy
tool out of several—including spending, grants, loans and loan
guarantees, and regulations—that policymakers can use to achieve public
goals. The choice of whether to use tax expenditures, spending, or other
tools depends on which approach better meets the goal at the lowest
cost.

•   Different policy tools may be more effective than others in achieving a
    particular policy outcome. With tax expenditures, certain activities may
    be cheaper and simpler to subsidize through the tax code because



8
 GAO, 2011 Tax Filing: Processing Gains, but Taxpayer Assistance Could Be Enhanced
by More Self-Service Tools, GAO-12-176 (Washington, D.C.: Dec. 15, 2011).




Page 5                                                                  GAO-12-760T
       IRS has the administrative infrastructure to collect and remit money to
       millions of taxpayers. For example, the incremental administrative and
       compliance costs to deliver the tax credit for child and dependent care
       expenses may be relatively low compared to the costs of setting up a
       separate system for processing child care applications and sending
       vouchers to those eligible. 9

•      How a tax expenditure is designed can affect its revenue effects and
       how it relates to the criteria for a good tax system. For example,
       depending on their design, tax expenditures can result in taxpayers
       receiving benefits for actions they would have taken absent the tax
       expenditure. Also, each type of tax expenditure creates tax savings in
       different ways and, consequently, reduces federal revenues in
       different ways and may have different distributional effects. The
       amount of tax relief per dollar that a taxpayer receives using an
       exclusion, exemption, or deduction depends on the taxpayer’s
       marginal tax rate. Generally, the higher a taxpayer’s marginal tax rate,
       the greater the tax savings from these tax expenditure types. Tax
       credits reduce tax liability dollar-for-dollar, so the value of a credit is
       the same regardless of a taxpayer’s marginal tax rate.

•      The Government Performance and Results Act (GPRA)
       Modernization Act of 2010 (GPRAMA) 10 can help in evaluating tax
       expenditures in that it establishes a framework for providing a more
       crosscutting and integrated approach to focusing on results and
       improving government performance. GPRAMA makes clear that tax
       expenditures are to be included in identifying the range of federal
       agencies and activities that contribute to crosscutting goals. Moving
       forward, GPRAMA implementation can help inform tough choices in
       setting priorities as policymakers address the rapidly building fiscal
       pressures facing our national government.

•      If not well designed or effectively implemented, tax expenditures can
       contribute to mission fragmentation and program overlap, thus
       creating the potential for duplication with other policy tools. All federal
       spending and tax policy tools, including tax expenditures, should be



9
 GAO, Government Performance and Accountability: Tax Expenditures Represent a
Substantial Federal Commitment and Need to Be Reexamined, GAO-05-690
(Washington, D.C.: Sept. 23, 2005).
10
    Pub. L. No. 111-352, 124 Stat. 3866 (Jan. 4, 2011).




Page 6                                                                 GAO-12-760T
     reexamined to ensure that they are achieving their intended purposes
     and are designed in the most efficient and equitable manner.
4. Measurement Challenges. Unavailable or insufficient data can hinder
policymakers’ ability to consider how the factors described above relate to
particular tax expenditures. A key challenge is that data necessary to
assess how and by whom a tax expenditure is used generally are not
collected on tax returns unless IRS needs the information to ensure tax
compliance or is legislatively mandated to collect or report the
information. In some cases, IRS may combine reporting requirements to
minimize its workload and taxpayer burden, and as a result, the
information collected may not identify specific beneficiaries or activities
targeted by a tax expenditure. Also, the influence of other economic and
social factors can confound efforts to measure a tax expenditure’s effects
on efficiency and equity. We and the Office of Management and Budget
(OMB) have noted that the desired outcomes of a tax expenditure or
other policy tool are often the combination of effects of the program and
external factors. 11

If policymakers conclude that additional data would facilitate reexamining
a particular tax expenditure, decisions would be required on what data
are needed, who should provide the data, who should collect the data,
how to collect the data, what it would cost to collect the data, and whether
the benefits of collecting additional data warrant the cost of doing so.
Another factor to consider is how to facilitate data sharing and
collaborative evaluation efforts amongst federal agencies.




 GAO, Designing Evaluations: 2012 Revision, GAO-12-208G (Washington, D.C.: Jan. 31,
11

2012); and Office of Management and Budget, Analytical Perspectives, Budget of the
United States Government, Fiscal Year 2013 (Washington, D.C.: 2012).




Page 7                                                                 GAO-12-760T
                      Our prior reports on tax expenditures illustrate how these factors can be
Illustrating These    used to help evaluate whether and how to extend expiring tax provisions.
Factors Using
                      Domestic Ethanol Production. Our past work related to domestic
Examples from GAO’s   ethanol production highlights the importance of considering how tax
Past Work             expenditures relate to other policy tools. 12 Congress has supported
                      domestic ethanol production through two policy tools: (1) a tax credit, the
                      most recent version of which expired after December 31, 2011, and (2) a
                      renewable-fuel standard that generally requires transportation fuels in the
                      United States to contain certain volumes of biofuels, such as ethanol. In
                      2009, we reported that the tax credit was important in helping to create a
                      profitable corn starch ethanol industry when the industry had to fund
                      investment in new facilities, but is less important now for sustaining the
                      industry because most of the capital investment has already been made.
                      We found that Congress’s efforts to support domestic ethanol production
                      through a tax credit and renewable-fuel standard were duplicative. The
                      fuel standard is now at a level high enough to ensure that a market for
                      domestic ethanol production exists in the absence of the ethanol tax
                      credit. As such, we suggested that Congress consider modifying the
                      credit or phasing it out. Congress allowed the credit to expire at the end of
                      2011. JCT did not include an estimate of the budgetary effect of
                      extending the credit through December 31, 2013, in its March 2012
                      estimates, as the President did not propose to extend the credit. 13

                      Higher Education. Our past work on higher-education tax expenditures
                      illustrates how tax expenditures that are not transparent (i.e., cannot be
                      easily understood by taxpayers) can result in taxpayers making decisions




                       GAO, Follow-up on 2011 Report: Status of Actions Taken to Reduce Duplication,
                      12

                      Overlap, and Fragmentation, Save Tax Dollars, and Enhance Revenue, GAO-12-453SP
                      (Washington, D.C.: Feb. 28, 2012); Opportunities to Reduce Potential Duplication in
                      Government Programs, Save Tax Dollars, and Enhance Revenue, GAO-11-318SP
                      (Washington, D.C.: Mar. 1, 2011); and Biofuels: Potential Effects and Challenges of
                      Required Increases in Production and Use, GAO-09-446 (Washington, D.C.: Aug. 25,
                      2009).
                       Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions
                      13

                      Contained in the President’s Fiscal Year 2013 Budget Proposal. JCT revenue estimates
                      compare predicted federal revenues under a proposal with predicted revenues under
                      present law. JCT provides a year-by-year comparison for a 10-year budget window, which
                      we provide for the examples listed below. Revenue estimates incorporate certain
                      behavioral responses.




                      Page 8                                                                    GAO-12-760T
that do not maximize their tax benefits. 14 The tuition and fees deduction,
which expired after December 31, 2011, helped students and their
families pay for higher education by allowing them to deduct qualified
education expenses from income that would otherwise be taxable. In
2008, we found that tax filers did not always claim higher-education tax
expenditures, such as the tuition and fees deduction, that maximize their
potential tax benefits, potentially because of the complexity of higher-
education tax provisions. 15 Further analysis and simplification of the tax
provisions involved could potentially increase transparency in the system.
JCT estimates the budgetary effect of extending this provision through
December 31, 2013, would be about $1.5 billion in fiscal years 2012-
2022.

Higher education tax expenditures also illustrate how measurement and
methodological challenges can impede evaluating their effectiveness. In
2005, we reported that little is known about the effectiveness of
education-related federal grants, loans, and tax expenditures in promoting
student outcomes including college attendance, students’ choice among
colleges, and the likelihood that students will continue their education. We
also found that research gaps may be due, in part, to data and
methodological challenges—such as difficulty isolating the behavioral
effects of the tax expenditure under study from other changes—that have
proven difficult to overcome.

Research Tax Credit. Our past work on the research tax credit provides
insights into how improving the design of a tax expenditure could improve
its economic efficiency and reduce revenue costs. 16 Economists widely
agree that some government subsidy for research is justified because the
social returns from research exceed the private returns that investors



14
  GAO, Higher Education: Multiple Higher Education Tax Incentives Create Opportunities
for Taxpayers to Make Costly Mistakes, GAO-08-717T (Washington, D.C.: May 1, 2008);
Student Aid and Postsecondary Tax Preferences: Limited Research Exists on
Effectiveness of Tools to Assist Students and Families through Title IV Student Aid and
Tax Preferences, GAO-05-684 (Washington, D.C.: July 29, 2005).
 In a forthcoming report, we will update our analysis on the extent to which filers select
15

higher education provisions that maximize their tax benefit.
16
  GAO-11-318SP; GAO, Tax Policy: The Research Tax Credit’s Design and Administration
Can Be Improved, GAO-10-136 (Washington, D.C.: Nov. 6, 2009); Tax Policy: Additional
Information on the Research Tax Credit, GAO/T-GGD-95-161 (Washington, D.C.: May 10,
1995).




Page 9                                                                          GAO-12-760T
receive. Since 1981, the research tax credit has provided significant
subsidies (an estimated $6 billion for fiscal year 2011) to encourage
business to invest in research and development. The most recent version
of the credit expired after December 31, 2011. Despite the widespread
support for the concept of a credit for increasing research activities,
concerns have been raised about the cost-effectiveness of the design of
the current credit and its administrative and compliance costs. We found
that the research tax credit, as currently designed, distributes incentives
unevenly across taxpayers and provides many recipients with windfall
benefits, earned for research that they would have done anyway. For
example, we found that for those claiming the regular credit, more than
half of the credit such claimants earned was a windfall. The disparities in
incentives can lead to an inefficient allocation of investment resources
across businesses, and the windfall benefits represent foregone tax
revenue that does not contribute to the credit’s objective. Accordingly, we
suggested that Congress modify the research tax credit to reduce
economic inefficiencies and excessive revenue costs. JCT estimates the
budgetary effect of the President’s proposal to enhance and make
permanent this provision would be about $99 billion in fiscal years 2012-
2022.

Our past work on the research tax credit also provides insight into how
tax expenditure design can affect transparency and administrability. In
2009, we reported that there are numerous areas of disagreement
between IRS and taxpayers concerning what types of spending qualify for
the research credit because of issues such as the definitions used to
determine eligibility and the documentation needed to support the claim.
These disputes raise the cost of the credit to both taxpayers and IRS and
diminish the credit’s incentive effect by making the ultimate benefit to
taxpayers less certain. We made several recommendations to the
Department of the Treasury (Treasury) to reduce the uncertainty that
some taxpayers have about their ability to earn credits for their research
activities. To date, Treasury has not fully implemented these
recommendations.

New Markets Tax Credit (NMTC). Our past work on the NMTC provides
examples highlighting issues of simplicity and the need to consider tax




Page 10                                                          GAO-12-760T
expenditures in light of other policy tools. 17 Congress enacted the NMTC
in 2000 as part of an ongoing effort to revitalize low-income communities.
Treasury awards tax credits to Community Development Entities (CDE),
which sell the credits to investors to raise funds. JCT estimates the
budgetary effect of the President’s proposal extending and modifying the
NMTC would be about $3.5 billion in fiscal years 2012-2022. 18

In 2007, we reported that the NMTC appeared to increase investment in
low-income communities. 19 However, in 2010 we reported that the
complexity of NMTC transaction structures appeared to make it difficult to
complete smaller projects and often results in less of the money investors
initially put into the project ending up in low-income community
businesses—the beneficiaries of NMTC financing—than would be the
case if the program were simplified. We suggested Congress consider
offering grants to CDEs that would provide the funds to low-income
community businesses and assess the extent to which the grant program
would increase the amount of federal subsidy provided to low-income
community businesses compared to the NMTC. One option would be for
Congress to set aside a portion of funds to be used as grants and a
portion to be used as tax credits under the current NMTC program to
facilitate a comparison of the two programs.

Revitalization Programs. Our past work on revitalization programs,
including the Empowerment Zone (EZ), Enterprise Community (EC), and
Renewal Community (RC) programs, provides an example of




 GAO-11-318SP; GAO, New Markets Tax Credit: The Credit Helps Fund a Variety of
17

Projects in Low-Income Communities, but Could Be Simplified, GAO-10-334 (Washington,
D.C.: Jan. 29, 2010).
 The President’s Fiscal Year 2013 Budget proposed extending the program through 2013
18

with $5 billion available for allocation in both 2012 and 2013. The proposal would also
modify the NMTC to offset alternative minimum tax liability.
19
  GAO, Tax Policy: New Markets Tax Credit Appears to Increase Investment by Investors
in Low-Income Communities, but Opportunities Exist to Better Monitor Compliance,
GAO-07-296 (Washington, D.C.: Jan. 31, 2007).




Page 11                                                                    GAO-12-760T
measurement challenges when evaluating tax expenditures. 20 Congress
established the EZ, EC, and RC programs to reduce unemployment and
generate economic growth in selected Census tracts. Urban and rural
communities designated as EZs, ECs, or RCs received grants, tax
expenditures, or a combination of both to stimulate community
development and business activity. Tax provisions for empowerment
zones and the District of Columbia (DC) enterprise zone (including the
first-time homebuyer credit for the District of Columbia) expired after
December 31, 2011. JCT estimates that the budgetary effect of extending
these provisions through December 31, 2013, would be $585 million from
fiscal years 2012-2022.

Our prior work has found improvements in certain measures of
community development in EZ communities, but data and methodological
challenges make it difficult to establish causal links. In the case of the EZ,
EC, and RC programs, the lack of tax benefit data limited the ability of the
Department of Housing and Urban Development (HUD) and the
Department of Agriculture to evaluate the overall mix of grant and tax
programs to revitalize selected urban and rural communities. In response
to our recommendations, HUD and the IRS collaborated to share data on
some program tax credits. However, the IRS data did not tie the program
tax incentives to specific designated communities, making it difficult to
assess the effect of the tax benefits. We have previously reported that if
Congress authorizes similar programs that rely heavily on tax
expenditures in the future, it would be prudent for federal agencies
responsible for administering the programs to collect information
necessary for determining whether the tax benefits are effective in
achieving program goals. 21

Nonbusiness Energy Property Credit. Our work on the nonbusiness
energy property credit highlights the importance of considering revenue


20
  GAO-11-318SP; GAO, Revitalization Programs: Empowerment Zones, Enterprise
Communities, and Renewal Communities, GAO-10-464R (Washington, D.C.: Mar. 12,
2010); Empowerment Zone and Enterprise Community Program: Improvements Occurred
in Communities, but the Effect of the Program Is Unclear, GAO-06-727 (Washington, D.C.:
Sept. 22, 2006); Community Development: Federal Revitalization Programs Are Being
Implemented, but Data on the Use of Tax Benefits Are Limited, GAO-04-306 (Washington,
D.C.: Mar. 5, 2004).
 GAO, Community Development: Limited Information on the Use and Effectiveness of
21

Tax Expenditures Could Be Mitigated through Congressional Action, GAO-12-262
(Washington, D.C.: Feb. 29, 2012).




Page 12                                                                   GAO-12-760T
foregone and the criteria for good tax policy when determining whether
and how to extend specific tax provisions. 22 Enacted as part of the Energy
Policy Act of 2005, the nonbusiness energy property credit was intended
to increase homeowners’ investment in energy-conserving improvements,
such as insulation systems, exterior windows, and metal roofs, by
reducing their after-tax costs. The credit expired on December 31, 2011.
JCT estimates the budgetary effect of the President’s proposal extending
and modifying this provision through December 31, 2013, would be about
$2.4 billion in fiscal years 2012-2022.

The design of the credit affects its economic efficiency and revenue costs.
The credit combines features of both cost-based and performance-based
credits. Cost-based credits provide incentives that are usually a fixed
percentage of qualified spending, whereas performance-based credits
provide incentives that are tied to specific measures of energy savings
and therefore may require before and after energy audits. The
nonbusiness energy property credit is cost-based in that the amount of
credit claimed is directly proportional to a taxpayer’s qualified spending. It
is performance-based in that only certain qualifying purchases are
eligible. In 2012, we reported that both the performance-based and cost-
based credits have advantages and disadvantages with neither design
being unambiguously the better option based on current information. For
example, a performance-based credit is more likely to effectively reduce
energy use and carbon dioxide emissions because it rewards energy
savings from the investment rather than the cost-based credit’s rewarding
of spending regardless of whether this spending results in energy
savings. However, the performance-based credit may have significant up-
front costs for energy audits, not required by the cost-based credit, which
could reduce its effectiveness by discouraging investment.

The credit’s design also can affect its administrability and equity. For
taxpayers who do invest, these up-front costs may mean that a
performance-based credit may have significantly higher taxpayer
compliance and IRS administrative costs than a cost-based credit. Views
on what is a fair distribution of the credit’s costs and benefits can differ
dramatically across individuals. However, whatever one’s views of




22
  GAO, Energy Conservation and Climate Change: Factors to Consider in the Design of
the Nonbusiness Energy Property Credit, GAO-12-318 (Washington, D.C.: Apr. 2, 2012).




Page 13                                                                  GAO-12-760T
fairness, an analysis of the distribution of costs and benefits by such
factors as income level can be useful.

Indian Reservation Depreciation. Our work on this provision is another
example of how measurement challenges can hinder evaluation of tax
expenditures. 23 The provision allows taxpayers to take larger deductions
for depreciation from their business income earlier than they otherwise
would be allowed for certain property on Indian reservations. For the
deduction, taxpayers are not required to identify the reservation on which
the depreciated property is located, preventing assessments linking
investment to economic indicators on specific reservations. We
suggested Congress consider requiring IRS to collect this information, but
we noted that Congress would need to weigh the associated costs of
collecting and analyzing the information as well as the effects on IRS’s
other priorities. The credit expired on December 31, 2011. JCT estimates
the budgetary effect of extending this provision through December 31,
2013, would be $100 million in fiscal years 2012-2022.

In closing, considering the various factors I have laid out today can help
when deciding whether and how to extend expiring tax provisions.
Improving tax expenditure design may enable individual tax expenditures
to achieve better results for the same revenue loss or the same results
with less revenue loss. Also, reductions in revenue losses from
eliminating ineffective or redundant tax expenditures could be substantial
depending on the size of the eliminated provisions. As we have stated in
prior reports, 24 we believe that tax expenditure performance is an area
that would benefit from enhanced congressional scrutiny as Congress
considers ways to address the nation’s long-term fiscal imbalance.


Chairman Tiberi, Ranking Member Neal, and Members of the
Subcommittee, this completes my prepared statement. I would be happy
to respond to any questions you and Members of the Subcommittee may
have at this time.



 GAO, Tax Expenditures: Available Data Are Insufficient to Determine the Use and
23

Impact of Indian Reservation Depreciation, GAO-08-731(Washington, D.C.: June 26,
2008).
 GAO-05-690 and GAO, Tax Policy: Tax Expenditures Deserve More Scrutiny,
24

GAO/GGD/AIMD-94-122 (Washington, D.C.: June 3, 1994).




Page 14                                                                  GAO-12-760T
                     For further information regarding this testimony, please contact James R.
Contacts and Staff   White, Director, Strategic Issues, at (202) 512-9110 or whitej@gao.gov.
Acknowledgments      Contact points for our Offices of Congressional Relations and Public
                     Affairs may be found on the last page of this statement. Individuals
                     making key contributions to this statement include Jeff Arkin, Assistant
                     Director; Shannon Finnegan; Melanie Papasian; MaryLynn Sergent; Anne
                     Stevens; and Sabrina Streagle. Kevin Daly, Tom Gilbert, Susan J. Irving,
                     Thomas McCabe, Timothy Minelli, Ed Nannenhorn, Michael O’Neill, and
                     Jim Wozny also provided technical support.




(450990)
                     Page 15                                                       GAO-12-760T
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