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2007 Income Tax Expenditure report

Interest in tax expenditures is never low – but the interest level soars when the state grapples with a significant budget deficit. In December 2007, we released our Income Tax Expenditures Report, which is a listing of all tax expenditures, and a comprehensive analysis of their revenue effects.

The term “tax expenditure” comes from a definition in federal law:

Revenue losses attributable to provisions of the federal tax laws that allow a special exclusion, exemption, or deduction from gross income, or which provide a special credit, a preferential rate of tax, or a deferral of tax liability. 1

The report considers only tax expenditures in California Corporation Tax, and California Personal Income Tax (PIT). PIT and Corporation taxes collected by FTB comprise 65.6 percent of the General Fund (Franchise Tax Board Annual Report 2006). The report’s analysis of specific expenditures is divided into the major categories of conformity and nonconformity expenditure items. The largest expenditure in the nonconformity category is exclusion of Social Security benefits, at $1.74 billion. Under conformity items, the top tax expenditure is exclusion of employer contributions to pension plans, at $4.9 billion.

Tax expenditures are further defined in relation to “normal income tax structure,” as provisions that reduce tax relative to “normal tax law.” Justification for tax expenditures is placed under two broad policy objectives: equity and behavioral incentives.

Equity

Tax expenditures are used to enhance the equitable nature of the tax system by providing relief to a group of taxpayers who incur monetary costs that are unusual to taxpayers as a whole. For example, blind taxpayers may claim the additional exemption for blindness. The function of the blindness exemption is to restore equity by compensating taxpayers for expenses specifically related to their blindness.

Behavioral incentives

Tax expenditures exist for a wide variety of behavioral incentives. They are designed to modify behavior in ways deemed by the Legislature to benefit taxpayers as a whole; behaviors that would probably occur less frequently if the behavioral incentives did not exist. For example, the tax credit for carpooling is intended to ease traffic congestion and reduce polluting emissions by reducing the number of vehicles on the roads. These outcomes benefit taxpayers as a whole, but individual taxpayers who decide to carpool might find the tax credit more persuasive than the greater public good. The outcome remains the same, however.

The full Tax Expenditure Report is available on our Website at ftb.ca.gov (search for “tax expenditure”). In addition to listing all tax expenditures and their costs, the report examines tax expenditures from various perspectives. It provides necessary context with discussion of “normal tax law,” policy motivations, administrative issues, and the disadvantages of, and alternatives to tax expenditures.

1 Congressional Budget and Impoundment Control Act of 1974 (P.L. 93-344), Section 3(3).