Testing the Tools Approach: Tax Expenditures versus Direct Expenditures

Testing the Tools Approach: Tax Expenditures versus Direct ExpendituresAuthor(s): Christopher HowardSource: Public Administration Review, Vol. 55, No. 5 (Sep. - Oct., 1995), pp. 439-447Published by: Wiley on behalf of the American Society for Public AdministrationStable URL: http://www.jstor.org/stable/976768 .

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Testng he Tool Approach: Tax Eendiures Versus Direct Expenditures

Christopher Howard, College of William & Mary

Several scholars have suggested reorienting the study ofppublicpol- icy away from programs and agencies and towardpolicy tools such as regulations and loan guarantees. They have developed a theo- reticaljustification for the tools approach and described the politics of individual tools. They have predicted several ways in which policy tools should differ but have offered little empirical evidence to demonstrate that important differences exist. The author investigates the extent to which policy tools differ by comparing tax expenditures to direct expenditures, two important policy tools. This comparison produces mixed results, suggesting the needforfrrther empirical study andfrrther refinement of the ways in which tools matter. In particular, the choice of tax expenditures versus direct expenditures appears to matter morefor the enactment of new programs than for their subsequent growth and administration.

Over the last 15 years, a number of scholars have called attention to the wide variety of policy tools used by gov- ernments. Led by Lester Salamon, they have tried to rewrite the usual equation of government equals direct expenditures plus laws and regulations by adding important but often overlooked policy tools such as loan guarantees and tax expenditures (policy tools are also known as policy instruments) (Fesler and Kettl, 1991; Hood, 1986; Leonard, 1986; Mosher, 1980; Salamon, 1981, 1989). The common thread linking these overlooked tools is that while they are publicly financed, the actual goods and services are delivered by private companies and nonprofits. One aim of this group has been to increase public awareness concerning the extent of "third-party government." Recent demands for privatization, they point out, are a little misleading because the national government has always relied heavily upon third parties to build military weapons, issue home mortgages, provide employees with health insurance, and the like. A second aim has been to raise questions of accountability. While some of these tools receive so little official scrutiny that their impact and effectiveness are unknown, others allow third parties considerable latitude in administering public programs.

Some of these scholars believe that a "tools approach" can significantly improve our understanding of policy making and public administration (e.g., the contributing authors in Salamon, 1989). In their view, previous research typically used the program or agency as the unit of analysis, focused on one or two cases in depth, and stressed the unique features of each case. Cumulative knowledge was slow to develop. By switching the unit of analysis to the policy tool, scholars will be able to general- ize more broadly. They will recognize patterns across programs and across agencies that use similar tools, and draw lessons concerning the proper use of each tool. Such knowledge would not only be good in and of itself but would also improve the quality of policy making.

Public Administration Review * September/October 1995, Vol. 55, No. 5 439



The utility of the tools approach hinges on a key assump- tion: policy tools do, in fact, exhibit distinctive patterns. To date, advocates have developed a theoretical justification for the tools approach and described the politics of individual tools. They have predicted several ways in which policy tools should differ but offered little empirical evidence to demonstrate that important differences exist. This observation is not meant as a criticism; most of these advocates have rightly started by laying the groundwork for future research. One of the first tasks is determining whether policy tools differ consistently, and to do that, one must compare their actual performance.

This article takes up that challenge. My purpose is to inves- tigate the extent to which policy tools differ by comparing tax expenditures to direct expenditures. These two tools have been chosen because Salamon (1989) and others consider them to be distinct. They are also important because they entail massive commitments of public resources and span the full range of functions performed by the national government. Our confi- dence in the tools approach would increase if we discovered differences between tools along several different dimensions. Ideal- ly, one would like to compare the performance of policy tools-how efficient and effective each is in achieving its prima- ry objectives. There are, however, remarkably few evaluations of tax expenditures (which may help to explain their popularity). Accordingly, in this article, I compare the creation, growth, and administration of tax expenditures and direct expenditures. Is one tool easier to enact than another? Does real (inflation- adjusted) spending for one consistently exceed the other? Is one tool easier to implement than another? These are crucial questions for groups making demands on government, elected officials, and public bureaucrats to answer, particularly when faced with greater fiscal constraints on and public skepticism of government.

This initial test of the tools approach produces mixed results. Considerable variation exists within tax expenditures and direct expenditures and overlap between them. In particular, the choice of tax expenditures versus direct expenditures matters more for the enactment of new programs than for their subsequent growth and administration. These results are an insuffi- cient basis for accepting or rejecting the tools approach and suggest the need for further empirical investigation.

A Word about Tax Expenditures Tax expenditures are popularly known as tax loopholes or tax

breaks. They are defined more formally as "departures from the normal tax structure.. .designed to favor a particular industry, activity, or class of persons" (Surrey and McDaniel, 1985; 3). They can take the form of tax deductions, tax credits, preferential tax rates, tax deferrals, or outright exclusion of income from taxation. Familiar examples include tax deductions for home mortgage interest and charitable contributions. Tax expenditures cost the national treasury approximately $400 billion in lost revenues in 1993.1 To put that figure in perspective, tax expenditures are about three-quarters the size of all discre- tionary direct expenditures and far exceed the national deficit.

I here are, however, remarkablyfew evaluations of tax

expenditures (which may help to explain their popularity).

They are almost the size of Social Security and Medicare combined.

Intuitively, it may seem strange to equate the failure to col- lect taxes with government spending, yet most public finance experts do (Musgrave and Musgrave, 1984; Pechman, 1987). They portray tax expenditures as a simultaneous exchange of income. Taxpayers write a check to the government for their full tax liability, and the government issues them a check to cover those activities exempted from taxation. The concept is rooted in notions of horizontal equity, which hold that equivalent amounts of income should be taxed at the same rate regard- less of the source of that income. Critics of the concept argue that tax expenditures simply allow people to keep what is right- fully theirs in the first place and should not be equated with direct outlays (Kristol, 1978). Their criticisms have been understood more as arguments against taxation and big government than against tax expenditures and have had little practical effect, even during Republican administrations. The major government agencies responsible for taxation recognize that tax expenditures and direct expenditures constitute alternative means of achieving the same policy objectives (U.S. Congress, 1992). Tax expenditures are, therefore, grouped in the same budget categories as direct expenditures in government documents. Although this practice facilitates comparisons, tax expenditures are nevertheless discussed in a separate appendix to the annual budget prepared by the Office of Management and Budget (OMB, 1994a, 1994b), rendering them less visible in budgetary debates.

The definition of tax expenditures, like any political catego- ry, contains a certain measure of arbitrariness. Tax expenditures are defined as deviations from the baseline tax system. The question then is, what counts as the baseline? By convention, tax rates do not, and neither do the standard deductions for dependents. Likewise, the relevant taxes are considered to be individual and corporate income taxes. The exemption of income above a certain level (currently around $60,000) from Social Security taxation, for example, is not counted as a tax expenditure, even though it resembles one. Not surprisingly, there are disagreements over individual provisions. Since the early 1980s, the executive agencies (Treasury and OMB) have adopted a slightly broader definition of the tax baseline than has Congress's Joint Committee on Taxation (CT), reflecting in large part differences in how to treat business investment. The OMB/Treasury list of tax expenditures is, therefore, somewhat shorter. Further, the executive and legislative agencies tend to use slightly different economic assumptions when estimating the costs of tax expenditures, and they sometimes categorize individual provisions differently (e.g., in Commerce versus Employment and Training). The sum total of these differences, however, is relatively minor. For the sake of consistency, in this article, I rely solely on JCT cost estimates, which have been

440 Public Administration Review * September/October 1995, Vol. 55, No. 5



available for many more years than have the alternative OMB estimates and are cited more often in the academic literature and public debates.

Enactment In theory, tax expenditures should be easier to enact than

direct expenditures. They are a less-visible form of spending and thus less likely to generate political opposition. Until the 1960s, the government did not publish estimates of the individual or aggregate costs of tax expenditures. Tax expenditures face fewer veto points in Congress because the House Ways and Means and Senate Finance committees serve as the equivalent of authorizing and appropriating committees. And tax expenditures rely almost exclusively on third parties in the private sector for service delivery. This structure expands the number of ben- eficiaries and strengthens the base of interest-group support for each program (Salamon and Lund, 1989; Surrey and McDaniel, 1985). The classic example is the home mortgage interest deduction, which is supported by home builders, realtors, con- struction unions, and financial institutions-all major contrib- utors to congressional and presidential election campaigns.

Although these are all plausible explanations for differences between tax expenditures and direct expenditures, one must first determine if there is indeed any significant variation to explain. Based on a comparison of new tax expenditures and new direct expenditures, this distinction seems valid. A chronology of the major programmatic innovations in social welfare during the 20th century is presented in Table 1. Admit- tedly, while this table does not reflect every spending initiative of the last 90 years, it does capture many landmark programs without becoming unmanageably long. This list is restricted to programs enacted at the national level (thus eliminating programs such as workers' compensation). Social programs are

those classified in government documents as income security, health, housing, social services, or employment and training. Innovation is defined to mean the introduction of a new function rather than any increase in benefits for existing functions or any renaming of existing programs. This definition elimi- nates, among other things, introduction of the Supplemental Security Income program in 1972, which combined and expanded upon previous direct expenditures for the elderly poor and the blind.

The programs traditionally associated with U.S. social policy are depicted on the lower half of Table 1. Almost all of these direct-expenditure programs were introduced during two brief periods, 1935-39 and 1961-65, commonly referred to as the two 'big bangs" of American welfare state development. Schol- ars have debated long and hard why new social programs have been so difficult to enact in the United States. Possible explanations range from liberal values and fragmented institutions to the relative weakness of organized labor and the strength of big business (for a good summary of these debates, see Weir, Orloff, and Skocpol, 1988). What matters for my purposes is simply the descriptive fact that such innovation has been rare.

The corresponding list of new tax expenditures are displayed on the upper half of Table 1. At least one new program was introduced in every decade between 1910 and 1990-a far more routine pattern than for direct expenditures. The patterns for each tool might be comparable if major tax expenditures were created in the 1930s and the 1960s and minor programs in other decades, but this is not the case. The original individual income tax passed in 1913 contained important tax subsidies for housing. As of 1993, the tax deductions for home mortgage interest ($44 billion) and property taxes on owner-occupied homes ($13 billion) cost the U.S. government more than twice as much as all direct expenditures for public housing and Sec- tion 8 vouchers. The tax expenditure for corporate retirement

Table 1 Chronology of Major Innovations in Social Welfare, 1910-1990

Tax Expenditures Extraordinary medical Capital gpins on home sales for those aged 55 and over (1964) expenses (1942)

Corporate health Medicare benefits (1970)

Home mortgage interest, benefits, child and Individual Retirement property taxes, casualty Corporate pensions (1914-1926) Capitalgainson dependent care Accounts (1974) losses, nonmortgage con- Capital gains on ~~~(1954) losses, nonmortgage con- home sales (1951) Retirement Earned Inc. Tax

sumerinterest (since1elim- Old Age and Survivors Insurance plans for the Credit (1975) (Social Security) benefits (1941) self employed Low inc.

| _______________ (1962) hou_ Ttax

~~93~~~ 1940 195* 1960 V ~~~~~~~~~crt 1 980 ] .......... . .. . .

....... ......

Disability insurance (1956) Medicare, Medi- Old-age insurance (Social Security), Old-age assis- Survivors' insurance (1939) Food stamps (1961) caid (1965) tance, unemployment insurance, Aid to Depen- Great Society programs in edu- dent Children, Aid to the blind (1935) Public housing (1937) cation, job training, and social Section 8 housing

Direct Expenditures services (1964) vouchers (1974)

Sources: U.S. Senate, 1992; Witte, 1985.

Testing the Tools Approach: Tax Expenditures Versus Direct Expenditures 441



pensions, which was created by a series of Treasury rulings and congressional acts between 1914 and 1926, is currently the fourth largest social program overall ($56 billion), after Social Security, Medicare, and Medicaid. All of these tax expenditures were created prior to the Social Security Act, when the only innovations were supposedly pioneered by state and local gov- ernments or large corporations (Berkowitz and McQuaid, 1992; Katz, 1986).

New tax expenditures appeared regularly between the 1930s and 1980s, and several of them grew to be quite large. This pattern shows no sign of abating in the 1990s. Policy makers created small tax expenditures for young children and child health insurance in 1990. Currently, a number of conservatives and moderates have suggested creating one or more new tax expenditures in order to help individuals purchase private health insurance. Such a move, in their view, would make health care more available without markedly increasing the level of government involvement, a sharp contrast to managed-com- petition or single-payer alternatives.

Several case studies suggest that the process of enacting tax expenditures has been as distinctive as their timing (Howard, 1992). Their introduction appears to have generated little of the controversy or interest that accompanied Social Security or Medicare. Instead, new tax expenditures were buried deep in revenue or tax-reform bills; often, no separate congressional votes were taken or hearings held. In short, new tax expenditures appear to follow a much different pattern than new direct expenditures. (Whether they do for the reasons cited above is still an empirical question to be resolved.)

Growth Advocates of a tools approach have advanced more hypothe-

ses about the creation and administration of policy tools than about their growth. Nevertheless, it seems fair to predict that the same factors that facilitate the enactment of tax expenditures should also promote their growth. Students of tax expenditures offer precisely this argument when referring to them as uncontrollable spending (Surrey and McDaniel, 1985; Leonard, 1986; Salamon, 1989). Tax expenditures are immune from the discipline of the annual appropriations process and rarely evalu- ated. Their cost was unknown prior to the 1960s and has not been prominently displayed in budget documents since then. Just as low visibility should be a political asset, so should the support of third-party providers. For instance, in the recent debates over health reform, insurance companies, doctors, and hospitals, among others, lobbied vigorously to preserve the tax expenditure for company-based health insurance (Cloud, 1994).

Such advantages do not, however, appear to translate into faster rates of growth in spending. The growth of tax expenditures and direct expenditures since the mid-i 960s are compared in Table 2. Overall, tax expenditures are estimated to have grown at a rate of 4.2 percent per year, adjusted for inflation, between 1967 and 1995. That rate is only marginally faster

than the 4.0 percent growth for direct expenditures between 1965 and 1995. (The starting points for each time series are slightly different because tax expenditure data were unavailable prior to 1967.) At the most aggregate level, there is no meaningful difference in growth rates between these two tools for a period of three decades.

Such a comparison, although interesting, potentially con- ceals interesting variations across time and among programs. Although space does not permit extensive analysis of the data here, a few finer grained comparisons would be useful. Table 2 also compares growth rates during several meaningful periods of the last three decades and demonstrates important variations. The first comparison covers the period 1965-1995 and has already been discussed. The second and third comparisons try to account for large-scale changes in the economy. During a period of economic growth (1965-1975), one might expect to find faster growth in all forms of spending. Indeed, the rate of growth in direct expenditures between 1965 and 1975 (5.5 percent) was well above that for the entire 1965-95 period (Table 2). Aided by a strong economy, the newly created Medicare and Medicaid programs grew rapidly, as did Social Security and a number of smaller Great Society programs. Spending on the Vietnam War escalated. Tax expenditures increased more rapidly as well (6.2 percent annually), thereby creating a more meaningful gap relative to direct expenditures. Although this finding suggests that economic growth favors tax expenditures over direct expenditures, one should be a little cautious considering the small absolute size of tax expenditures circa 1970, which made any increase in spending appear large.

Whatever advantages tax expenditures enjoyed, they appear to have diminished in the subsequent period of economic stress. Many studies indicate that wages, productivity, and gross domestic product (GDP) have stagnated since the mid-1970s,

Table 2 Tax Expenditures versus Direct Expenditures, 1965-1995 (Real Annual Rates, in Percent)

1965-95Ea 1965-75 1975-95Ea 1980-90 Totals Direct expenditures 4.0 5.5 3.2 4.0 Tax expendituresb 4.2 6.2 3.4 2.1

Direct Expenditures Total 4.0 5.5 3.2 4.0 Total - defense 5.2 8.2 3.8 3.9 Total - income security 3.7 4.6 3.3 4.4 Total - health 3.3 4.8 2.6 3.7

Tax Expendituresb Total 4.2 6.2 3.4 2.1 Total - housing 3.8 6.0 2.9 1.3 Total - income security 4.3 7.7 2.9 0.9 Total - health 3.9 6.2 3.0 1.6

Notes: Cost figures in this and the following tables are adjusted for inflation using CPI-U deflators.

a E refers to estimated costs. b Figures for tax expenditures are unavailable prior to 1967, so that year is

used rather than 1965 when calculating the relevant growth rates. Sources: U.S. Congress, Joint Committee on Taxation, Estimates of Federal

Tax Expenditures (Washington, DC: U.S. Government Printing Office, various years); Office of Management and Budget, 1994a, 1994b.




Tax expenditures depend in large part on economic

activity: stronger growth usually produces more tax

revenues, which in turn increases the value ofany

exemptionsfiom taxation. so the period 1975-1995 is considered a time of stress. Growth rates in both forms of spending dropped by almost one-half, and the gap between them narrowed during this period. Tax expenditures grew at a rate of 3.4 percent compared to 3.2 percent for direct expenditures. It should not be too surprising that patterns of spending growth for both tools follow patterns of economic growth. Tax expenditures depend in large part on economic activity: stronger growth usually produces more tax revenues, which in turn increases the value of any exemptions from taxation. Stronger growth also enables more people to buy homes and more employers to offer their workers health insurance and retirement pensions, which also increases the cost of the relevant tax expenditures. For their part, many direct expenditures are indexed to changes in the economy.

One might wonder how these forms of spending fare in periods of political stress. During the 1980s, Republican presidents repeatedly promised to curb the growth of government spending (meaning direct expenditures), and between 1981 and 1987 they enjoyed the support of a Republican-controlled Senate. Ronald Reagan, in particular, succeeded in cutting income taxes and slashing spending for a number of domestic programs in his first term. Nevertheless, as many readers know, these spending cuts were swamped by increases for national defense, health care, and interest on the debt. Direct expenditures grew just as fast during the 1980s as they did between 1965 and 1995 (and faster than spending in the Carter and Clinton administrations). Oddly, direct expenditures fared much better than tax expenditures during the 1980s, despite the Reagan-Bush administrations' commitment to lower tax burdens. Their rate of growth (4.0 percent) was almost twice that of tax expenditures (2.1 percent). The main drag on tax expenditures was the Tax Reform Act of 1986, which reduced the value of many provisions when it lowered marginal tax rates, an indirect but nonetheless highly effective means of curbing tax expenditures. More recently, the budget accords of 1990 and 1993 have required any new or modified tax expenditure to be revenue- neutral, thus charging advocates of this tool with the onerous task of finding the money to pay for their program. The supposed political advantages of tax expenditures were, therefore, irrelevant and perhaps even counterproductive between 1980 and 1990. This decade is the one period in which important differences in growth rates appear, but they favor direct expenditures and not, as predicted, tax expenditures.

Because each tool of spending is dominated by a few programs, these aggregate patterns could be heavily influenced by one or two outliers. Currently, approximately three-fifths of tax expenditures go to housing, income security, and health (pri-

marily subsidies for homeownership and corporate pension and health insurance benefits). About two-thirds of direct expenditures go toward national defense, income security (mostly Social Security), and health (Medicare and Medicaid). What happens to aggregate growth rates when we start to remove some of these functions?

Individual budgetary functions can have a large impact on overall growth rates (Table 2). Removing defense raises the growth of direct expenditures from 4.0 to 5.2 percent between 1965 and 1995. Removing income security lowers the growth rate to 3.7 percent, and removing health lowers the growth rate considerably, to 3.3 percent. By implication, defense spending must have grown more slowly than average spending and income security and health, more rapidly. Once one starts to examine shorter time periods, however, the effects of removing a given budgetary function start to vary, sometimes increasing and sometimes decreasing the overall growth rate of the remain- ing spending. Health is the only one of these categories to exhibit a consistent pattern. It grew faster than average in all four time periods, and because of its size, health had a large impact on total spending growth.

Tax expenditures reveal a similar pattern. Housing and health programs tended to grow faster than average, so their removal usually lowered aggregate growth rates. While income security had little impact between 1967 and 1995, its growth varied within this period; it alternately restrained and accelerat- ed the overall rate of growth. The impact of income security tax expenditures was particularly marked during the 1980s, for without them tax expenditures would only have grown half as rapidly as they did.

The greater the effect of removing one budgetary function, the greater variance in growth rates one might expect to find across budget functions. For instance, because housing, income security, and health tax expenditures all involve large amounts and grew faster than average in the 80s, one would expect that many other categories grew slower than average to compensate. Tables 3 and 4 present growth rates for all budgetary functions for both tools, and they help to confirm this expectation. Indeed, one is struck by the tremendous variation in growth rates within each tool. In each of four different time periods, some categories of direct expenditures grew like gangbusters, some kept slightly ahead of inflation, and some actually shrank in size (Table 3). A similar picture is apparent for tax expenditures (Table 4). Moreover, there are periods of expansion and contraction within some budget functions (e.g., energy) and consistently strong growth in others (e.g., health). One is hard pressed to find any consistent pattern that separates the growth of tax expenditures from that of direct expenditures. To be fair, it does not appear as if budget function, a more common unit of analysis in the academic literature, provides any better handle on growth rates. Growth rates in similar budget functions are comparable in some cases (energy, health), and not in others (international affairs, science, space, and technology).

Tables 2-4 suggest that whatever differences may exist in political support for tax expenditures and direct expenditures do




Table 3 Real Growth of Direct Expenditures, 1965-1995 (Cost in Billions of Dollars of Budget Outlays)

Cost Rates of Annual Growth (%) Budget Function 1993 1965-95Ea 1965-75 1975-95Ea 1980-90 National defense 291.1 1.0 0.3 1.3 4.6 International affairs 16.8 - 0.6 - 2.0 0.2 - 2.7 Science, space, and technology 17.0 - 1.1 - 8.4 2.8 5.6 Energy 4.3 1.7 9.7 -2.1 -13.8 Natural resources/environment 20.2 2.6 5.8 1.0 - 1.5 Agriculture 20.4 - 0.7 - 7.4 2.8 - 0.5 Commerce and housing -22.7 N.A. 17.9 N.A. 17.5 Transportation 35.0 1.7 1.4 1.9 - 0.3 Community and regional development 9.1 2.5 8.9 - 0.6 - 6.2 Education 30.0 5.8 13.8 2.1 0.7 Employment and training 7.6 4.3 15.3 - 0.9 - 8.5 Social services 12.4 9.1 24.8 2.0 1.0 Health 230.0 13.0 24.2 7.8 7.0 Medicare 130.6 8.4* 8.2** 8.4 7.9

Income security 511.8 5.6 9.9 3.6 3.1 Social Security 304.6 5.4 8.4 3.9 3.9

Veterans 35.7 1.8 5.8 - 0.1 - 0.4 Administration of justice 15.0 7.2 12.7 4.5 4.3 General government 13.0 2.8 15.4 - 3.0 - 5.4 Interest 198.8 6.3 5.0 6.9 9.4 Offsetting receipts -37.4 2.0 3.4 1.3 2.5 Total 1,408.2 4.0 5.5 3.2 4.0

Note: Includes on-budget and off-budget outlays. a E refers to estimated costs. b Figures for Commerce and Housing are distorted because of large positive and negative outlays for

deposit insurance beginning in the 1980s (i.e., the S&L crisis). *1970-95E. **1970-75. Sources: Office of Management and Budget, 1994a, 1994b.

not translate into any consistent difference in growth rates. Sometimes tax expenditures grow (a bit) faster and sometimes they grow more slowly. Moreover, by disaggregating the totals, one observes considerable differences in growth rates within each tool. This finding would seem to diminish the utility of policy tools as a unit for analysis.

Administration The difficulties of translating good intentions into good out-

comes are well understood by advocates of the tools approach. One of their chief concerns is that the number of mechanisms available for achieving public purposes has outstripped our ability to manage them well. Housing officials have to think like bankers when administering home-loan guarantee programs. Treasury officials have to make retirement policy when deciding which firms' pensions qualify for preferential tax treatment. Consequently, several of their initial hypotheses concern the administration of policy tools.

Unfortunately, these hypotheses point in two different direc- tions where tax expenditures are concerned. On the one hand, Salamon and Lund (1989) suggest that less visible tools will be easier to enact but harder to manage than more visible tools. Tax expenditures should, therefore, be harder to manage than direct expenditures. On the other hand, they also suggest that more automatic tools should be easier to administer than tools

that require active involvement by public authorities (e.g., in determining eligibility and benefit levels). The tradeoff is that more automatic programs do not always serve their intended targets. Tax expenditures are considered to be one of the most automatic of policy tools because: (1) taxpayers determine their own eligibility and benefits, based on fixed formulas and proce- dures; (2) they may never have to come face-to-face with a single bureaucrat; and (3) the Treasury Department administers tax expenditures as part of their routine revenue-collecting function. Tax expenditures should, therefore, be easier to administer than direct expenditures. This latter assess- ment is the one most commonly advanced by advocates of tax expenditures (Surrey and McDaniel, 1985).

Closer examination of three cases reveals some of the hidden complexity of administering tax expenditures (Howard, 1992). The tax expenditure for corporate pensions, the largest loophole in the entire tax code, is arguably the single most difficult social program to administer. There are almost 1,000 pages of regulations issued by the Internal Revenue Service stipulating what pension plans must do to qualify for favorable tax status. The most important of these regula-

tions govern the distribution of pension benefits within a firm, called nondiscrimination rules, to ensure that senior executives do not reap too many of the benefits. Other sections cover min- imum funding standards, maximum allowable contributions and benefits, penalties for early withdrawal, and the number of years required to vest.

Understanding any one of these sections is a formidable task. A recent article in the professional journal Tax Notes, for example, included a 13-page flow chart to guide employers trying to comply with nondiscrimination rules. The chart simply indi- cated the relevant sections of the tax code, with no explanation of their substantive meaning (Lipsig, Hezlep, and Nelson, 1991). Taken together, 'the Federal laws and regulations gov- erning employer-provided retirement benefits are recognized as among the most complex set of rules applicable to any area of the tax law"-no mean feat (U.S. Congress, 1990; 2).

The sheer volume and complexity of pension rules have spawned an entire industry of actuaries, accountants, and tax lawyers who specialize in corporate pensions. All of these individuals are paid well for their expertise. To keep up with recent changes and clarifications, they consult a variety of specialized journals, including Benefits Law Journal, Employee Benefit Plan Review, Employee Benefits Journal, Journal of Pension Planning and Compliance, Pension World, and Pensions & Investments. Other, more general journals such as Tax Notes also devote significant coverage to pension regulations. For a self-executing




policy tool, this program requires a lot of help, but not in the form of greater government employment or spending. Many of the costs of administration are shifted from government to employers and are thus dis- guised from public view.

The Targeted Jobs Tax Credit (TJTC) repeats this pattern on a much smaller scale. The TJTC has always been one of the smallest tax expenditures-its cost is expressed in millions, not billions. This tax credit is available to employers who hire certain categories of disadvantaged workers. Its value is based on the workers' salaries and duration of employment. As with corporate pensions, the TJTC has generated business for firms that help employers determine which of their employees qualify and then complete the necessary paper- work. Such firms have been particularly important in helping small companies, which often lack specialized personnel or finance departments, to participate in the program.

The need for such expertise has been driv- en partly by the complicated and changing definitions of "disadvantaged workers," initi- ated by Congress. And it was due partly to the inability of state employment service agencies (SESAs) to certify that workers were eligible for the program and issue them a TJTC voucher. SESAs were a logical choice to assume this responsibility because they already assisted many disadvantaged workers with job searches and job training. Nevertheless, Congress did not appropriate enough funds for SESAs to perform these tasks (in effect, an unfunded mandate). Out of necessity, other public agencies- vocational rehabilitation agencies, Veterans Administration offices, Social Security offices, local welfare agencies-were allowed to certify some of their clients as TJTC eligible (U.S. Departments of Labor and Treasury, 1986). Administrative burdens have, therefore, been pushed down from the national to the state and local levels and from the public sector to the private sector. Some evaluations have suggested that these burdens have compromised the program's effectiveness (Bishop and Kang, 1991; Levitan and Gallo, 1987).

Although administration of the Earned Income Tax Credit (EITC) has required an equally diverse set of actors, their efforts have been more coordinated. The EITC functions like a wage subsidy for workers at or near the poverty line. Based on a per- centage of earnings, the EITC is usually large enough to offset whatever income taxes are owed and entitle the recipient to a tax refund. The combination of revenues lost and refunds issued currently costs the government about $14 billion per year and is slated to expand to $20 billion by the end of the decade (Howard, 1994). To obtain these benefits, eligible workers take one of two routes. They either complete the relevant parts of

Table 4 Real Growth of Tax Expenditures, 1967-1995 (Estimated Cost in Billions of Dollars of Revenues Lost)

Cost Rates of Annual Growth (%) Budget Function 1993 1967-95Ea 1967-75 1975-95Ea 1980-90 National defense 2.1 0.5 - 1.2 1.2 - 1.8 International affairs 8.3 7.5 16.3 4.1 4.0 Science, space, and technology 1.8 0.3 - 2.7 1.6 - 6.2 Energy 1.5 - 1.7 5.4 - 4.4 -17.8 Natural resources/environment 2.2 16.0* 75.1** 4.7 2.4 Agriculture 0.9 - 5.9 0.2 - 8.3 -16.7 Commerce and housing 142.4 4.4 9.8 2.3 - 0.1 Commerce 61.7 2.8 10.8 - 0.3 - 4.4 Housing 80.7 6.5 7.7 6.0 6.6

Transportation 0.2 17.1 66.7 1.7 8.8 Community and regional development 0.7 N.A. N.A. 7.9 9.7 Education 4.3 2.2 3.6 1.6 - 1.4 Employment and training 9.5 11.5 0.1 16.4 7.6 Social services 17.6 2.6 1.7 2.9 4.0 Health 65.8 6.8 6.2 7.0 6.0 Income security 100.5 3.9 1.1 5.1 6.4 Veterans 1.7 - 0.3 - 0.7 - 0.2 0.0 General purpose fiscal assistance 41.6 3.6 7.0 2.3 - 0.4 Interest 1.3 N.A. N.A. 0.1 8.1 General government N.A. N.A. N.A. N.A. N.A.

Total 402.4 4.2 6.2 3.4 2.1 Notes: Tax expenditures for general government only existed from the mid-1970s to the mid-1980s

and were always less than $1 billion. Because of the inherent difficulties of adding tax expenditures, these sums should be treated as ballpark estimates.

a E refers to estimated costs. *1970-95E. **1970-75. Sources: U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax Expenditures (various years).

the annual 1040 or 1040A tax forms, which provide a lump- sum benefit. Or they apply for the advance-payment option, which reduces the tax bite of each paycheck, by filling out a short form with their employer.

Neither route has been free of obstacles. Trying to aid the poor through the U.S. tax code is inherently difficult. They tend to have less formal education and less access to professional help than other taxpayers. They are, therefore, more likely to misinterpret eligibility guidelines and miscalculate their benefits. The other factor working against them, ironically, is that over the last decade most low-income taxpayers have been eliminated from the income tax rolls. They have little reason to bother with tax forms unless they know ahead of time that they are eligible for an EITC refund.

Consequently, steps need to be taken to publicize the program and help recipients complete the necessary forms. Because the main mission of the IRS is not to help people avoid taxation, a number of groups have assumed responsibility for administering this program. The most important of these is the Center on Budget and Policy Priorities, a Washington-based research and advocacy organization specializing in poverty issues. The center has coordinated a nationwide campaign to promote the EITC since the late 1980s. It has worked with a host of local government agencies, nonprofit organizations, churches, labor unions, and corporations to raise public awareness and help people obtain benefits.




Their help was made even more necessary by changes enacted in 1990. The addition of two new supplemental credits forced the IRS to issue a separate tax form (Schedule EIC) for the program-a move widely criticized at the time for making benefits more difficult to obtain. Congress eliminated these two credits in 1993, and the IRS hopes to return the EITC to a single line on the annual tax form.

The obstacles to advance payment have been more persistent (Howard, 1992, 1994). Less than one-tenth of 1 percent of eligible workers use the advance-payment option, which policy makers intended to be the main route for receiving the EITC. As opposed to a lump-sum payment several months in the future, advance payment offers cash to people who often live paycheck to paycheck, and it enhances the program's work incentives. Recent studies indicate that many employers and employees were simply unaware of this option, that some employers who were aware objected to the additional paper- work, and that some employees feared receiving too large a benefit and owing taxes at the end of the year. The IRS has promised to step up its efforts to publicize this option, and Congress took steps in 1993 to prevent EITC recipients from owing any money. Still, considering how few people use advance payment now, it will be a while before it becomes widespread.

For all three of these tax expenditures, one could make the argument that the administrative burden in Washington is lower than for comparable direct expenditures. For instance, even if Social Security's administrative costs are only 1 percent of benefits, the program still requires a sizeable bureaucracy, far larger than the many Treasury officials and IRS agents who deal with corporate pensions. It is much harder to argue that the total administrative burden is lower. Policy tools may differ less with respect to the number of administrative headaches and more with respect to their location.

Conclusions The idea that policy influences politics is a familiar one in

political science. Theodore Lowi (1964) argued 30 years ago that regulatory, distributive, and redistributive policies had distinct politics. Several years later, James Q. Wilson (1973) countered that the distribution of costs and benefits better determined who would participate in a given issue and what the outcome would be. Each of these models subsequently exerted considerable influence on the study of public policy as scholars tried to determine exactly when and why these models worked. Each model acquired its own set of proponents and critics. Proponents touted the models' parsimony and ability to predict a wide range of out- comes. Critics tended to view these models as too deterministic, as neglecting the roles that strategy, passion, and historical contin- gency play in policy making (e.g., Stone, 1988).

It seems fair to predict a similar fate for the tools approach. Conceptually, this approach has much to recommend it. It promises from the start to encompass the full range of government activities, not just direct expenditures and regulations. Its

advocates intend to advance the understanding of government so that better policy decisions programs can be made and can be administered better-both worthy goals. Its advocates have produced a number of testable hypotheses concerning funda- mental issues in public policy and public administration. They have suggested plausible reasons why one might expect different policy tools to exhibit different patterns of policy making. These advocates also happen to be some of the leading scholars in the field.

Like any theory or conceptual framework, the tools approach has certain limitations, at least with respect to distin- guishing tax expenditures from direct expenditures. As predicted, tax expenditures have been easier to enact than direct expenditures. On the other hand, it does not appear that one of these policy tools grows faster than the other. Indeed, it is hard to make any meaningful generalizations about growth given the sizable variations within each tool. Furthermore, while tax expenditures do appear easier to manage from the perspective of public administrators in Washington, that may not be the only consideration that matters. Rather than eliminate administrative burdens, tax expenditures appear to shift them from public officials to individual and corporate taxpayers (and to a lesser extent, state and local agencies). From a systems perspective, the administrative advantages of tax expenditures over direct expenditures are smaller than they appear.

In sum, some of the special properties that are supposed to distinguish one policy tool from another do not clearly distinguish tax expenditures from direct expenditures. There is still plenty of room for powerful interests, historical accidents, clever strategies, formal institutions, and ideas-that is, "politics"-to have an impact (Howard, 1992). This evidence is clearly not enough to justify dismissing or ignoring the tools approach. Some advocates might respond to this evidence by arguing that tax expenditures and direct expenditures were really variants of the same tool and, therefore, should not be expected to diverge. In that case, they would need to provide a rationale for combin- ing what have traditionally been viewed as separate tools, and to explain the decidedly different patterns of enactment. Or they might concede some overlap between these two tools and insist that other tools would prove to be more distinct from each other. Alternatively, they might argue that the list of features compared above was either irrelevant or incomplete, and that a more "honest" test would produce different results. And they might be right. Until we have more empirical evidence, however, we will be left to conjecture about the real worth of the tools approach. For now, all we have are some initial indications that the tools approach may be unable to account for some important features of policy making.

Christopher Howard is an assistant professor of government at the College of William & Mary and also teaches in the college's Thomas Jefferson Program in Public Policy. He has published articles concerning public policy in the American Political Science Review, Journal of Policy History, Political Science Quar- terly, and The American Prospect.




Notes Part of this project was supported by a 1994 Summer Research Grant

from the College of William & Mary, for which the author is grateful. The author would also like to thank the editors and several anonymous reviewers for their helpful suggestions.

1. This total is based on figures published by Congress' Joint Committee on Taxation (1992). It should be treated as a good ballpark estimate, since experts disagree over how best to sum tax expenditures (e.g., Gilbert and Gilbert, 1989; Witte, 1985).

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Testing the Tools Approach: Tax Expenditures versus Direct Expenditures

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