If you sell insurance, retirement savings products or investment products in the United States, you face a complicated fact of life: Whatever you might think about the U.S. federal income tax system, that system shapes the products and services you sell.
When the tax code lets your clients take deductions, or benefit from gains in the value of assets without immediately paying federal taxes on the gains, you might think of that as the Internal Revenue Service keeping its hands off of your clients' hard-earned money.
(Related: AALU to Congress: Don't Touch Our Products)
Under the Congressional Budget Act of 1974, however, federal budget managers define tax exclusions, preferential tax rates, tax liability deferrals and other tax breaks as "tax expenditures," or federal revenue losses due to tax breaks.
The Annual Tax Expenditure Lists
The 1974 budget law requires workers at the federal Office of Management and Budget, an arm of the White House, to prepare detailed lists and descriptions of federal tax expenditures every year.
The OMB staff publishes the tax expenditure list in Analytical Perspectives, a budget guide that cames out at the same time as the president's budget proposal.
The OMB puts tax expenditures in subject-related categories and gives each expenditure a number.
The first category, for example, is for National Defense. Tax expenditure Number 1, which falls in that category, is for the "exclusion of benefits and allowances to armed forces personnel."
The second category is for International Affairs. Tax expenditure Number 2 is for the exclusion of income earned outside the United States by U.S. citizens.
The OMB also creates another table, of great interest to anyone who works in financial services, that ranks tax expenditures by size, with the biggest one on top and the smallest at the bottom.
Tax Expenditure Wrestling
The United States will have about $19 trillion in gross domestic product, or national income, this year, according to the Bureau of Economic Analysis.
President Donald Trump's budget proposal for fiscal 2018, which starts Oct. 1, shows that the country might raise $3.7 trillion in revenue in 2018 and spend about $4.1 trillion.
The value of all of the tax expenditures on the OMB tax expenditure list amounts to about $1.5 trillion. In theory, eliminating all of the tax expenditures might wipe out the budget deficit.
Chess pieces (Image: Thinkstock)
In reality, it's possible that eliminating some of the tax expenditures could change the economy or taxpayers' behavior in ways that would just make the budget deficit worse.
In Congress, however, the rules make it easier for bills that might cut the federal budget deficit by more than a certain amount to come up for a vote on the Senate floor.
Members of Congress and their aides scour the tax expenditure ranking tables for ideas about expenditures to try to cut, because they sincerely want to cut the federal budget deficit, they want to find a "pay for" for a new spending program, or they want to create a bill that will qualify for easy access to the Senate floor.
Three of the biggest, juiciest targets for would-be tax expenditure killers have to do with health care and retirement savings.
For any groups with an interest in health insurance, annuities, defined benefit pension plans or other financial services products, including the groups that represent insurance agents, financial planners and other financial professionals, the list creates what amounts to a giant multi-dimensional tax expenditure chessboard. Groups may create unexpected alliances in an effort to defend each other's tax expenditures, or get into unexpected battles because of tax-expenditure-related conflicts.
Here's a look at the 10 biggest tax expenditures in the latest OMB rankings, and how they've changed in the past year.
To allow, as much as we could, for apples-to-apples comparisons, we're giving the 2017 tax expenditure value estimates from the new Analytical Perspectives guide that came out with the 2018 budget proposal, along with the 2016 tax expenditure value estimates from the Analytical Perspectives guide that came out with former President Barack Obama's 2017 budget proposal.
We ranked the tax expenditures in order based on the 2017 value estimates.
We're also giving you the full description of each tax expenditure that appears in the latest Analytical Perspectives guide, so you can see how the OMB staff thinks of that item.
(Image: Thinkstock)
10. Deductibility of charitable contributions, other than education and health
2016 value estimate: $44.2 billion
2017 value estimate: $47.5 billion
Change between 2016 and 2017: +7.5%
Official description:
The baseline tax system would not allow a deduction for personal expenditures including charitable contributions. In contrast, the Tax Code provides taxpayers a deduction for contributions to charitable, religious, and certain other nonprofit organizations. Taxpayers who donate capital assets to charitable organizations can deduct the assets' current value without being taxed on any appreciation in value. An individual's total charitable contribution generally may not exceed 50% of adjusted gross income; a corporation's total charitable contributions generally may not exceed 10% of pretax income.
9. Step-up basis of capital gains at death
2016 value estimate: $58.3 billion
2017 value estimate: $52 billion
Change between 2016 and 2017: -11%
Official description:
Under the baseline tax system, unrealized capital gains would be taxed when assets are transferred at death. It would not allow for exempting gains upon transfer of the underlying assets to the heirs. In contrast, capital gains on assets held at the owner's death are not subject to capital gains tax under current law. The cost basis of the appreciated assets is adjusted to the market value at the owner's date of death which becomes the basis for the heirs.
8. Deductibility of nonbusiness state and local taxes other than on owner-occupied homes
2016 value estimate: $51.4 billion
2017 value estimate: $59.8 billion
Change between 2016 and 2017: +16%
Official description:
Under the baseline tax system, a deduction for personal consumption expenditures would not be allowed. In contrast, the Tax Code allows taxpayers who itemize their deductions to claim a deduction for state and local income taxes (or, at the taxpayer's election, state and local sales taxes) and property taxes, even though these taxes primarily pay for services that, if purchased directly by taxpayers, would not be deductible. (The estimates for this tax expenditure do not include the estimates for the deductibility of State and local property tax on owner-occupied homes.)
