5. Speck - Transforming Tax Expenditures (Print)


 

 

ARTICLE 

TRANSFORMING TAX EXPENDITURES 

Sloan G. Speck* 

 
For decades, reformers have advocated the repeal of tax 

expenditures—disguised government spending through special 
preferences in the Internal Revenue Code. And yet, tax 
expenditures persist, impairing federal tax receipts by more 
than $1.8 trillion in 2024. This Article introduces a novel 
mechanism for tax expenditure reform. To the extent that direct 
statutory repeal proves impossible or impractical, lawmakers 
can achieve an equivalent result through a strategy of 
legislative anti-repeal. By radically expanding a tax 
expenditure’s legal scope, then adjusting progressive income 
tax rates to account for revenue loss and distributional 
considerations, lawmakers can effectively eliminate tax 
expenditures from the tax base and integrate them into the rate 
structure—a process this Article defines as “base-rate 
transformation.” 

Base-rate transformations reframe conventional 
understandings of repeal and restrictive reform, as well as 
traditional reform narratives oriented around a mantra of 
“broad base, low rates.” Under certain conditions, statutory 
expansion operates as de facto repeal—or as restrictive reform. 
The crucial insight is that, for tax expenditures, the stakes of 
legal change lie largely in how lawmakers address any 
adjustments to statutory rates. From a normative perspective, 
base-rate transformations have implications for customary tax 
 

* Associate Professor of Law, University of Colorado Law School. Thanks 
to Heather Field, Kate Goldfarb, Tracey Roberts, Daría Roithmayr, Eleanor 
Wilking, and participants at the 2021 International Meeting on Law & 
Society, the 2021 Junior Tax Scholars Workshop, the James Hausman Tax 
Law and Policy Workshop at the University of Toronto School of Law, and 
the University of Colorado Work-in-Progress Series for helpful comments 
and discussion, as well as to Sam Astorga for excellent research assistance. 



  

616 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

norms such as equity, efficiency, and complexity, as well as the 
political economy of tax expenditure reform. More generally, 
base-rate transformations challenge standard framings of tax 
expenditures and press for a more holistic approach to 
legislative changes to these provisions. 
 
Introduction .......................................................................... 617 
I. Tax Expenditures: The Career of a Concept ................... 623 

A. Loophole Rhetoric .................................................... 626 
B. Disguised Spending and Upside-Down Subsidies . 628 
C. Base Expansion and Efficiency-Oriented Reform . 632 
D. Comparative Institutional Advantage ................... 635 
E. A Relational Definition of Tax Expenditures ........ 636 

II. Lawmaking and the Base-Rate Identity ........................ 637 
A. Tax Bases, Rates, and Revenue Constraints ......... 640 

1. Economic Definitions ........................................... 640 
2. Legal Definitions .................................................. 642 

B. The Base-Rate Identity in Action ........................... 643 
1. Classified Property Taxes .................................... 644 
2. Capital Gains Preferences ................................... 646 
3. Depreciation Recapture for Real Property ......... 647 
4. The Dividends Received Deduction ..................... 649 

III. Transforming Tax Expenditures ................................... 650 
A. Radical Expansion ................................................... 650 

1. Universal Application .......................................... 651 
2. Uniform Benefits .................................................. 653 
3. Incomplete Expansion ......................................... 656 

B. Correlative Adjustments in Theory ........................ 657 
1. Revenue Neutrality .............................................. 659 
2. Distributional Neutrality .................................... 660 
3. Efficiency .............................................................. 661 

C. Correlative Adjustments in Application ................ 663 
1. Fixed-Dollar Benefits ........................................... 664 
2. Proportionate Benefits ......................................... 667 
3. Regressive and Progressive Fixed-Dollar Benefits

 ............................................................................... 669 
4. Regressive and Progressive Proportionate Benefits

 ............................................................................... 674 
IV. Policy Considerations ..................................................... 679 



  

No. 2] TRANSFORMING TAX EXPENDITURES 617 

A. Incomplete Rate Adjustments ................................ 679 
B. Incomplete Expansion or Repeal ............................ 681 
C. Simplicity ................................................................. 682 
D. Political Economy .................................................... 682 
E. Expanding Options .................................................. 684 

V. Base-Rate Transformations in Action ............................ 684 
A. Tax Expenditures for Health Insurance ................ 685 

1. Transforming Health Insurance Taxation ......... 687 
2. Health Insurance and Tax Expenditure Analysis

 ............................................................................... 695 
B. Standard Deductions and Demogrants .................. 696 
C. The § 199A Pass-Through Deduction ..................... 698 

1. What Is the Pass-Through Deduction? ............... 700 
2. Repeal, Lapse, and Reform .................................. 705 
3. Transforming the Pass-Through Deduction ....... 712 

Conclusion ............................................................................. 713 
 

INTRODUCTION 
 

A foundational tenet of contemporary tax reform in the 
United States involves the repeal or restrictive reform of tax 
expenditures.1 Whether denominated as special preferences, 
loopholes, pernicious deviations from a comprehensive tax 
base, or disguised government spending or regulation, tax 
expenditures make easy villains.2 Policymakers, members of 

 
1 For an early expression of this tenet, see Stanley S. Surrey, Tax 

Incentives as a Device for Implementing Government Policy: A Comparison 
with Direct Government Expenditures, 83 HARV. L. REV. 705 (1970). The 
scope of tax expenditures—and the concept’s intellectual coherence—is 
controversial. See, e.g., Richard Krever, Analysing Implicit Tax 
Expenditures, 35 MELB. U. L. REV. 426 (2011) (taking a cross-country 
comparative approach to tax expenditures). 

2 Congress defines tax expenditures as provisions of law 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.” See Congressional Budget Act of 1974, Pub. L. No. 93-344, 
§ 3(a)(3), 88 Stat. 297, 299. The idea that tax expenditures deviate from a 
normative tax base, however, raises serious conceptual and definitional 
issues. See Boris I. Bittker, A “Comprehensive Tax Base” as a Goal of Income 
Tax Reform, 80 HARV. L. REV. 925, 926–27 (1967). 



  

618 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

the media, and academics argue that the presence of tax 
expenditures in the Internal Revenue Code (the Code) impairs 
the classical tax virtues of equity, efficiency, and simplicity.3 
The conventional solution is repeal, with possible replacement 
by direct spending.4 And yet, tax expenditures persist.5 As of 
2024, the U.S. Department of the Treasury (Treasury) 
identified 165 tax expenditures worth trillions of dollars in 
revenue over a ten-year budget window.6 

This Article introduces a novel approach to tax expenditure 
reform. As a structural alternative to statutory repeal or 
tailored reform, this Article proposes radical expansion, 
coupled with correlative adjustments to progressive income 
tax rates—a process that this Article defines as “base-rate 
transformation.” This approach represents a significant shift 
in tax policy thinking. By generalizing the benefits of tax 
expenditures across the tax base and adjusting rates 
 

3 These critiques are not limited to any specific ideology or political 
orientation. See, e.g., Chuck Marr & Brian Highsmith, Reforming Tax 
Expenditures Can Reduce Deficits While Making the Tax Code More 
Efficient and Equitable, CTR. FOR BUDGET & POL’Y PRIORITIES 1, 11 (2011) 
(noting tax expenditure reform proposals from both Democrats and 
Republicans), https://www.cbpp.org/sites/default/files/atoms/files/4-15-
11tax.pdf [https://perma.cc/L2LY-C23D]. 

4 See STANLEY S. SURREY, PATHWAYS TO TAX REFORM: THE CONCEPT OF 
TAX EXPENDITURES 179–80 (1973); see also Daniel N. Shaviro, Rethinking 
Tax Expenditures and Fiscal Language, 57 TAX L. REV. 187, 201 (2004) 
(arguing that tax expenditure budgets were “meant to serve as a hit list, 
identifying tax provisions that should be repealed and either disappear 
altogether or else reappear as direct spending, and not just placed on a par 
with direct spending whenever budgetary balance was evaluated”). 

5 Tax expenditures’ durability is not simply a story of political economy. 
Academic skepticism about tax expenditure analysis also contributes to 
these provisions’ persistence. See Shaviro, supra note 4, at 187–88. 

6 Off. of Tax Analysis, U.S. Dep’t of the Treas., Tax Expenditures FY2025 
(2024). See Tax Pol’y Ctr., What Is the Tax Expenditure Budget?, TAX POL’Y 
BRIEFING BOOK (Jan. 2024) (finding $1.8 trillion in total tax expenditures 
for 2024), https://taxpolicycenter.org/briefing-book/what-tax-expenditure-
budget [https://perma.cc/NS2N-KWHA]; see also Linda Sugin, Tax 
Expenditures, Reform, and Distributive Justice, 3 COLUM. J. TAX. L. 1, 9 
(2011) (“Congress has embraced tax expenditures and increased their 
number.”). Sugin notes that current tax expenditure budgets list more than 
three times as many provisions than Treasury’s earlier iterations. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 619 

accordingly, this approach aims to simplify the tax code, 
reduce distortions caused by targeted tax incentives, and 
maintain desired levels of distribution and revenue 
generation. In this sense, base-rate transformations mirror 
the net effects of conventional repeal, in that base-rate 
transformations, when carried out in an ideal manner, 
essentially neutralize tax expenditures’ equity, behavioral, 
and revenue effects. But legislative change is almost never 
ideal, and the stakes of base-rate transformations lie in their 
relationship to other second-best policy solutions. 

A simple example illustrates the equivalency between 
conventional repeal and base-rate transformations.7 Consider 
a pernicious special deduction that is claimed by 20% of 
taxpayers in a flat amount of $500 per claimant.8 Congress 
repeals this special deduction by excising the relevant 
provision from the Code. After repeal, prechange claimants 
pay tax on $500 of additional taxable income, while prechange 
nonclaimants, who did not benefit from the special deduction, 
pay tax on the same income. To decouple repeal of the special 
deduction from repeal’s intrinsic revenue-raising effects,9 
Congress reduces generally applicable statutory rates such 
that total revenue remains constant.10 Although prechange 
claimants and nonclaimants both benefit from lower rates, 
prechange claimants have more taxable income. For this 

 
7 This Article develops a series of numeric models to illustrate base-rate 

transformations. See infra Part III.C. 
8 This analysis treats the desirability of repeal as a baseline assumption, 

albeit one that is clearly counterfactual in some circumstances. For a 
discussion that addresses poorly targeted tax expenditures, see infra Part 
III.A. 

9 The amount of revenue raised is the $500 deduction, multiplied by 
prechange claimants’ marginal tax rates. 

10 One reason to repeal tax expenditures is to raise revenue without the 
need to increase statutory rates. The political economy of wholesale rate 
increases, as compared to one-off eliminations of tax expenditures, is an 
empirical one. Intertemporal issues and the possibility of bundling or 
logrolling complicate the legislative analysis. See Jason Oh, Will Tax 
Reform Be Stable?, 165 U. PENN. L. REV. 1159, 1219 (2017) (arguing that, 
over time, “[t]ax expenditures are enacted and modified in an ad hoc 
manner”). 



  

620 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

reason, prechange claimants pay more in tax after this 
correlative rate adjustment, while prechange nonclaimants 
pay less.11 

Alternatively, Congress could extend this special 
deduction to the other 80% of taxpayers—a radical expansion 
of the deduction’s scope. Now, all taxpayers receive the special 
deduction. Prechange claimants pay tax on the same income, 
while prechange nonclaimants pay tax on income that is $500 
less. To maintain constant total revenue (and thus allow for a 
like-to-like comparison with the repeal scenario), statutory 
rates must increase.12 Prechange claimants and nonclaimants 
both suffer under higher statutory rates, but prechange 
nonclaimants have less taxable income. After adjusting the 
rate structure, prechange claimants pay more in tax, and 
prechange nonclaimants pay less. Depending on how 
Congress redraws rates, the amount of tax paid by claimants 
and nonclaimants can be the same as that paid in the repeal 
scenario.13 Under these conditions, repeal and expansion yield 
identical results, and, ceteris paribus, lawmakers, 
policymakers, and the public should be indifferent between 
these legislative strategies.14 

Comparable intuitions apply in the context of reform, 
where tax expenditures are modified rather than eliminated. 
Repeal and universalization are endpoints along a continuum 
of policy change,15 and restrictive or expansive reform simply 
 

11 This change has efficiency implications, in that deadweight loss is 
less. See infra Part III.C. 

12 This increase could occur over time. See infra Part III.B. 
13 That is, effective tax rates are identical between the two scenarios, 

which implies that deadweight social loss also is the same. This conclusion 
is demonstrated mathematically in Part III.C, infra. 

14 For various reasons, including the relative salience of changes in tax 
rates and the tax base, this indifference is unlikely to hold. See, e.g., Ari 
Glogower & David Kamin, The Progressivity Ratchet, 104 MINN. L. REV. 
1499, 1554–57 (2020) (discussing “the unique political salience of the top 
statutory tax rates”).  

15 More accurately, repeal and universalization are edges in a 
multidimensional policy space. See Matthew D. McCubbins, Roger G. Noll 
& Barry R. Weingast, Structure and Process, Politics and Policy: 
 



  

No. 2] TRANSFORMING TAX EXPENDITURES 621 

represents incremental movement between these extremes. 
For any reform that restricts a tax expenditure’s scope (and, 
under the conceits of the prior example, leads to a reduction 
in statutory rates), there exists a corresponding base-rate 
transformation that expands the tax expenditure’s scope, 
subject to a generally applicable rate increase. Without more 
(and there is, of course, more in the legislative process), no 
intrinsic principle favors a reduction in scope over an 
expansion. Base-rate transformations are the yin to the yang 
of repeal and restrictive reform. 

The crucial insight is that, for tax expenditures, the stakes 
of legal change lie largely in how lawmakers address any 
adjustments to statutory rates.16 Whether lawmakers should 
favor restriction or expansion depends on the political 
availability and as-applied nature of these correlative rate 
changes—and on not the fact of tax expenditures’ restriction 
or expansion as an independent matter. In some cases, the 
optimal policy response may favor universalization over 
repeal.17 Current discourse, however, generally neglects 
universalization as a meaningful alternative in tax reform.18 
 
Administrative Arrangements and the Political Control of Agencies, 75 VA. 
L. REV. 431, 435–37 (modelling policymaking within a two-dimensional 
policy space). 

16 For decades, rates have factored into the tax expenditure literature, 
explicitly or implicitly. See SURREY, supra note 4, at 126–74. 

17 See infra Parts III.D & III.E. 
18 The academic and policy literature on the repeal or restrictive reform 

of tax expenditures is legion. For foundational work that emerged in the 
1970s, see William D. Andrews, Personal Deductions in an Ideal Income 
Tax, 86 HARV. L. REV. 309 (1972); SURREY, supra note 4; Surrey, supra note 
1. For a small selection of more recent treatments, see, e.g., Lily L. 
Batchelder, Fred T. Goldberg, Jr. & Peter R. Orszag, Efficiency and Tax 
Incentives: The Case for Refundable Tax Credits, 59 STAN. L. REV. 23 (2006); 
Conor Clarke & Edward Fox, Note, Perceptions of Taxing and Spending: A 
Survey Experiment, 124 YALE L.J. 1252 (2015); Steven A. Dean, The Tax 
Expenditure Budget Is a Zombie Accountant, 46 U.C. DAVIS L. REV. 265 
(2012); Jason S. Oh, The Social Cost of Tax Expenditure Reform, 66 TAX L. 
REV. 63, 64 (2012); Edward A. Zelinsky, James Madison and Public Choice 
at Gucci Gulch: A Procedural Defense of Tax Expenditures and Tax 
Institutions, 102 YALE L.J. 1165 (1993). For historical overviews of the 
 



  

622 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

By developing the structure and contours of base-rate 
transformations, this Article remedies that omission. 

One additional caveat: this Article approaches tax 
expenditures from a policy-agnostic perspective. In general, 
tax expenditures ostensibly serve some social or other 
normative policy function.19 For example, taxpayers may elect 
to pay tax on a three-year moving average of their income from 
farming and fishing businesses, rather than their actual 
income from these businesses in the current taxable year.20 
Presumably, this averaging protects farmers and fishers from 
income fluctuations, perhaps due to volatile prices or resource 
yields. In turn, these income fluctuations distort lifetime tax 
liabilities in a progressive rate structure predicated on annual 
assessment. Of course, this special provision also could reflect 
venal special interest lobbying, an express desire to subsidize 
agricultural activities, or a particular solicitude for those 
whose livelihood stems from the land or sea. These various 
supporting rationales imply different outcomes under a 
repeal-or-reform analysis.21 Instead of delving into these 
rationales, this Article assumes that tax expenditures (as a 
constructed category) are subject to repeal or restrictive 

 
concept, see Shaviro, supra note 4, at 199–206; JOHN F. WITTE, THE POLITICS 
AND DEVELOPMENT OF THE FEDERAL INCOME TAX 271 et seq. (1985). 

19 Identifying this social function is harder for some tax expenditures 
than others. See, e.g., Dennis J. Ventry, Jr., The Accidental Deduction: A 
History and Critique of the Tax Subsidy for Mortgage Interest, 73 L. & 
CONTEMP. PROBS. 233, 257–58 (2010) (describing critiques about the home 
mortgage interest deduction’s logic and effectiveness that emerged in the 
1950s); see also infra Part V.B (discussing the pass-through deduction in 
§ 199A). 

20 I.R.C. § 1301. Presumably, taxpayers elect a three-year average when 
their resulting tax liability is lower. Treasury estimates that this provision 
reduces federal tax revenue by more than $200 million annually. See Off. of 
Tax Analysis, supra note 6, at 24. Treasury lists six additional tax 
expenditures that benefit agriculture. See Off. of Tax Analysis, supra note 
6, at 9. 

21 Indeed, there might be good policy reasons to universalize income 
averaging. See Lee Anne Fennell & Kirk J. Stark, Taxation over Time, 59 
TAX L. REV. 1, 2–3 (2005) (comparing income averaging to age-based income 
tax systems). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 623 

reform.22 This approach emphasizes lawmakers’ options in the 
reform process, rather than the normative specifics of reform. 

This Article proceeds as follows. Part I briefly surveys the 
academic literature on tax expenditure reform and proposes a 
structural definition of tax expenditures that emphasizes the 
connections between the tax base and tax rates. Part II 
establishes the arithmetic relationship between the legal 
definitions of the tax base and tax rates—what this Article 
terms the “base-rate identity.” Part III details the operation 
of base-rate transformations as a vehicle for tax expenditure 
reform, including several numeric examples that demonstrate 
the computational equivalence between repeal and base-rate 
transformations. Part IV develops various policy 
considerations that inform the choice between conventional 
repeal or restrictive reform, on the one hand, and base-rate 
transformations, on the other. Part V explores three case 
studies that elaborate the idea and operation of base-rate 
transformations in the context of tax benefits for health 
insurance,23 general welfare transfers such as the Earned 
Income Tax Credit,24 and the deduction for business income 
earned by noncorporate taxpayers either directly or through 
pass-through entities.25 

 
I. TAX EXPENDITURES: THE CAREER OF A 

CONCEPT 
 

As an idea in U.S. tax policy, tax expenditures present a 
pair of paradoxes. First, the staff of the Joint Committee on 
Taxation (JCT) and the Office of Tax Analysis in Treasury 
prepare exhaustive annual reports, known as tax expenditure 
budgets, that list these “special” provisions with line-by-line 

 
22 Many empirical questions about tax expenditures’ efficacy are “quite 

difficult to resolve.” See David M. Schizer, Limiting Tax Expenditures, 68 
TAX L. REV. 275, 280 (2015). 

23 See I.R.C. §§ 105, 106 (establishing an exclusion for employer-
provided health insurance plans). 

24 I.R.C. § 32. 
25 I.R.C. § 199A. 



  

624 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

numeric revenue costs.26 But, as a concept, tax expenditures 
elude precise definition,27 and, among policymakers, 
economists, and legal experts, no general consensus exists 
about the content of—or dollar values attached to—items in 
these tax expenditure budgets.28 Second, with a surprising 
degree of solidarity, commentators support repeal or 
substantive limitation (what this Article denotes as restrictive 
reform) for an extensive suite of tax expenditures,29 including 
popular tax benefits for health care, homeownership, 
retirement savings, and charitable contributions.30 
Notwithstanding a general scholarly and public policy 
impetus for tax expenditure reform, these headline 

 
26 These reports also quantify the projected revenue losses associated 

with each tax expenditure. For the reports, see Off. of Tax Analysis, supra 
note 6, at 24–37; Staff of Joint Comm. on Tax’n, 118th Cong., Estimates of 
Federal Tax Expenditures for Fiscal Years 2023–2027, at 31–42 (Comm. 
Print 2023). 

27 See Shaviro, supra note 4, at 191 (“The distinction between taxes and 
spending thus depends on pure form.”); David A. Weisbach & Jacob Nussim, 
The Integration of Tax and Spending Programs, 113 YALE L.J. 955, 957 n.1, 
972–82 (2004) (“The term ‘tax expenditures’ is subject to much dispute.”). 

28 See J. Clifton Fleming & Robert J. Peroni, Can Tax Expenditure 
Analysis Be Divorced from a Normative Tax Base?: A Critique of the “New 
Paradigm’” and Its Denouement, 30 VA. TAX REV. 135, 145–48 (2010) 
(critiquing efforts to divorce tax expenditure analysis from conceptions of 
economic income). 

29 See Oh, supra note 18, at 64 (noting support from politicians and 
policy experts for tax expenditure repeal); see also Daniel Hemel & Kyle 
Rozema, Inequality and the Mortgage Interest Deduction, 70 TAX L. REV. 
667, 668–70 (2017) (analyzing the distributional consequences of repeal for 
the home mortgage interest deduction); David M. Schizer, Limiting Tax 
Expenditures, 68 TAX L. REV. 275, 291 (2015) (“A tax expenditure . . . that is 
counterproductive obviously is a promising candidate for repeal.”). 

30 See, e.g., Robert Bellafiore, Tax Expenditures Before and After the Tax 
Cuts and Jobs Act, TAX FOUND. (Dec. 18, 2018), 
https://taxfoundation.org/data/all/federal/tax-expenditures-pre-post-tcja 
[https://perma.cc/CFB2-B6BF]; Policy Basics: Federal Tax Expenditures, 
CTR. ON BUDGET & POL’Y PRIORITIES (Dec. 8, 2020), 
https://www.cbpp.org/research/policy-basics-federal-tax-expenditures; 
Frank Sammartino & Eric Toder, Tax Expenditure Basics, TAX POL’Y CTR. 
(Jan. 22, 2020), https://www.taxpolicycenter.org/publications/tax-
expenditure-basics [https://perma.cc/YG9G-8DKN]. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 625 

provisions—and many more obscure tax expenditures—still 
stand. 

These tensions within terminology—that tax expenditures 
are simultaneously highly specified and protean, at once 
targets for change and lasting pillars of statutory law31—were, 
to a significant extent, present from the concept’s beginnings 
as a policy construct in the 1950s and 1960s.32 And yet, the 
concept has traveled well over time, both politically33 and as 
the organizing principle for a robust academic literature.34 As 
Congress deploys the Code increasingly for social purposes 

 
31 Since the 1980s, the home mortgage interest deduction has been 

described as the “third rail” of U.S. tax reform. See Ventry, supra note 19, 
at 234–35 (providing a list of rhetoric that “immunized” the home mortgage 
interest deduction from reform and “entrenched” the policy over time). 

32 See Shaviro, supra note 4, at 199–203. 
33 For example, the first Trump Administration’s signature legislative 

achievement, the Tax Cuts and Jobs Act of 2017 (TCJA), reduced the 
estimated revenue lost to tax expenditures claimed by rank-and-file 
taxpayers. This reduction occurred even though the total number of JCT-
identified tax expenditures increased. The TCJA accomplished this reform 
by doubling the standard deduction, which dramatically reduced the 
proportion of taxpayers claiming itemized deductions. The TCJA also 
capped individuals’ deductions for state and local taxes and prospectively 
limited the home mortgage interest deduction for large borrowings. Eric 
Toder, The Tax Cuts And Jobs Act Reduced Tax Expenditures But by Much 
Less than the 1986 Tax Reform Act, TAX POL’Y CTR. (Dec. 10, 2019), 
https://taxpolicycenter.org/taxvox/tax-cuts-and-jobs-act-reduced-tax-
expenditures-much-less-1986-tax-reform-act [https://perma.cc/KU73-
KFZ6]. Similarly, the Biden Administration’s 2025 budget advocated 
eliminating various “loopholes” that benefit high earners. The Biden 
Administration’s 2025 budget also proposed expanding tax expenditures for 
housing. See Off. of Mgmt & Budget, Budget of the U.S. Government, Fiscal 
Year 2025, at 90 (2024) (“The Budget expands the existing Low-Income 
Housing Tax Credit and proposes a new Neighborhood Homes Tax Credit.”). 

34 See, e.g., Special Issue on Economic Analysis of Tax Expenditures, 64 
NAT. TAX J. 451 (2011). For a brief history of tax expenditures in policy and 
political debates, see C. Eugene Steuerle, The New Old Tax Expenditure 
Debate, Part 1, 95 TAX NOTES 1521 (June 3, 2002); C. Eugene Steuerle, The 
New Old Tax Expenditure Debate, Part 2, 95 TAX NOTES 1671 (June 10, 
2002); C. Eugene Steuerle, The New Old Tax Expenditure Debate, Part 3, 95 
TAX NOTES 1817 (June 17, 2002) [hereinafter Steuerle, Part 3]. 



  

626 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

within the individual income tax system,35 tax expenditures 
are “everywhere and organizing everything.”36 But, as a 
concept, tax expenditures are also somewhat diluted in their 
intellectual coherence, “like a nova entering its red giant 
phase.”37 This Part outlines various conceptual approaches to 
tax expenditures, then proposes a structural definition for tax 
expenditures that highlights the interplay between the tax 
base and statutory rates. 

 
A. Loophole Rhetoric 

 
Since the advent of the modern income tax in the early 

twentieth century, colloquial understandings of tax 
“loopholes” have motivated calls for legal change.38 Although 
the category of loopholes is not coextensive with tax 
expenditures,39 the two terms have similar negative valence 
when the stakes involve reform.40 Congress enables loopholes 

 
35 See Weisbach & Nussim, supra note 27, at 997–98 (describing an 

increase over time in “[s]ocial tax expenditures”); see generally Steuerle, 
Part 3, supra note 34 (“By the beginning of the 21st century, [there emerged] 
a set of tax expenditures that is much more geared toward social spending 
than business and investment expenditures.”). 

36 This language, not originally applied to tax expenditures, is from 
Daniel T. Rogers, Republicanism: The Career of a Concept, 79 J. AM. HIST. 
11, 11 (1992). 

37 Id. 
38 See, e.g., Two Reports on Tax, THE WASHINGTON POST, Mar. 15, 1912, 

at 4 (noting opponents’ critiques of a pre-Sixteenth-Amendment income-
based excise tax proposal as “crudely drawn and afford[ing] many loopholes 
for the evasion of the taxes sought to be imposed”); see generally LAWRENCE 
ZELENAK, FIGURING OUT THE TAX: CONGRESS, TREASURY, AND THE DESIGN OF 
THE EARLY MODERN INCOME TAX (2018) (establishing the legislative and 
administrative development of the early U.S. income tax). 

39 See Heather M. Field, A Taxonomy for Tax Loopholes, 55 HOUS. L. 
REV. 545, 554 (2018). 

40 See Boris I. Bittker, Income Tax “Loopholes” and Political Rhetoric, 
71 MICH. L. REV. 1099, 1112–14 (1973) (noting that linguistic substitutes 
“for ‘tax loopholes’ to avoid [the term’s] pejorative connotation . . . rarely 
achieve[]” that objective). The Biden Administration’s 2025 budget referred 
to some tax expenditures as “loopholes.” See Off. Mgmt. & Budget, supra 
note 33, at 45–46 (identifying the “so-called ‘like-kind exchange loophole’”). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 627 

by commission and omission, as well as by inaction in the face 
of pernicious tax planning or changing economic 
circumstances.41 Conventional tax expenditure analysis 
assumes that tax expenditures tend toward inequity because 
of infirmities in the tax legislative process, and expert-
produced tax expenditure budgets, regardless of their 
effectiveness, are expressly designed to inform lawmakers 
about overuse and abuse by taxpayers.42 The linkage between 
tax expenditures and pejorative loophole rhetoric implies a 
clear policy solution: closure by repeal.43  

Since the 1990s, the burgeoning of tax expenditures as 
affirmative social policy tools has pressured the connections 
between loophole rhetoric and tax expenditures. Many 
current tax expenditures apply broadly and have significant 
popular support—whether or not that support is justifiable.44 
For example, in the housing context, Congress has enacted 
affirmative preferences for interest paid on certain home 

 
41 See Gerard M. Brannon, Tax Loopholes as Original Sin, 31 VILL. L. 

REV. 1763, 1765–66 (1986) (arguing that many loopholes result from “the 
original sin of sloppy thinking about defining income”). 

42 For a description and critique of tax expenditure budgets’ role to 
inform about abuse, see Dean, supra note 18, at 267–70. 

43 See Bittker, supra note 40, at 1113 (noting that repeal is “the fate that 
might be hypothesized for a loophole of the classical variety”); Stanley S. 
Surrey, The Congress and the Tax Lobbyist: How Special Tax Provisions Get 
Enacted, 70 HARV. L. REV. 1145, 1148–49 (1957) (“[D]espite an absence of 
consensus on any particular list of provisions there seems to be considerable 
agreement that Congress in its tax legislation has adopted provisions 
favoring special groups or special individuals and that these provisions run 
counter to our notions of tax fairness.”); see also Brannon, supra note 41, at 
1763–64 (describing political rhetoric about tax reform that “has a good-
guy/bad-guy theme” with respect to “special interest provisions”); Field, 
supra note 39, at 564 (“[T]he speaker, by affixing the “loophole” label, has 
concluded that a particular preference violates one or more norms of good 
tax policy.”). 

44 WITTE, supra note 18, at 285 (“[I]t is incorrect to perceive the tax 
expenditure system as primarily a method of distributing hidden benefits 
to very narrow and highly organized groups . . . . As it is, most of the money 
is spread very broadly among large segments of the population and 
corporate world.”). 



  

628 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

loans and for gains on the sales of principal residences.45 
Congress also has failed to tax imputed income from owner-
occupied housing.46 From a political perspective, however, the 
chances of direct repeal seem remote.47 Indeed, the Biden 
Administration proposed expanding tax benefits for housing, 
particularly for first-time homeowners.48 Although tax 
expenditure analysis emerged from loophole rhetoric, the 
linkage has eroded over time.49 

Still, any origin story for tax expenditures must account for 
loophole rhetoric, and this connection explains, in part, policy 
experts’ generally one-sided perspectives on repeal. Loopholes 
imply closure as a solution, and the ethos of tax expenditures 
revolves around limitations and the targeting of benefits. Of 
course, tax expenditures may present a more fundamental 
problem. For example, tax expenditures may compare 
unfavorably to regulation because tax relief functions as a 
substitute for direct spending that itself operates poorly.50 
Loophole rhetoric tends to emphasize provision-by-provision 
reform, rather than a more holistic approach to government 
action. 

 
B. Disguised Spending and Upside-Down Subsidies 

 
45 See I.R.C. §§ 163(h)(3), 121. 
46 See Ventry, supra note 19, at 236 (discussing imputed income). 
47 See Ventry, supra note 19, at 281–83 (outlining replacements for the 

home mortgage interest deduction but arguing that “politicians appear 
addicted to subsidizing housing regardless of cost”). The TCJA severely 
curtailed the home mortgage interest deduction through both direct and 
indirect means. 

48 See Off. Mgmt. & Budget, supra note 33, at 17 (proposing credits for 
“middle-class first-time homebuyers” and “middle-class families who sell 
their starter home . . . to another owner-occupant”). 

49 Loophole rhetoric is complicated by changes over time in the moral 
valence of tax planning. See Steven A. Bank, When Did Tax Avoidance 
Become Respectable?, 71 TAX L. REV. 123, 125–28 (2017). 

50 See Brian Galle, The Tragedy of the Carrots: Economics and Policy in 
the Choice of Price Instruments, 64 STAN. L. REV. 797, 849 (2012) (“[T]he 
most basic problem with tax expenditures is not, as critics until now have 
complained, that they are part of the tax code, but rather that they are 
expenditures.”); see also infra Part I.D. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 629 

 
Tax expenditures also are characterized as disguised 

spending through the Code, which emphasizes two potentially 
deleterious effects of these provisions’ use. First, by routing 
government action through the tax system, tax expenditures 
create a “submerged state” that exerts power over markets in 
ways not salient in the legislative process or to the general 
public.51 This submerged state can subvert democracy and 
circumvent public policy norms, which supports a legislative 
requirement for annual tax expenditure budgets that 
ostensibly surface these aspects of state action. Some 
equivalency exists between revenue-losing tax provisions and 
direct government spending. Making the former explicit 
places the categories on more equal ground.52 
Notwithstanding the questionable empirics of such 
information’s value in the political process, the implication 
again leans towards the repeal or substantive reform of tax 

 
51 See Suzanne Mettler, THE SUBMERGED STATE: HOW INVISIBLE 

GOVERNMENT POLICIES UNDERMINE AMERICAN DEMOCRACY 4–5 (2011) 
(“[T]he policies of the submerged state remain largely invisible to ordinary 
Americans.”); see also Suzanne Mettler, From Pioneer Egalitarianism to the 
Reign of the Super-Rich: How the U.S. Political System Has Promoted 
Equality and Inequality over Time, 68 TAX L. REV. 563, 603 (2015); see 
generally BRIAN BALOGH, A GOVERNMENT OUT OF SIGHT: THE MYSTERY OF 
NATIONAL AUTHORITY IN NINETEENTH-CENTURY AMERICA (2009) 
(establishing a tradition of indirect government action in the nineteenth 
century); CHRISTOPHER HOWARD, THE HIDDEN WELFARE STATE: TAX 
EXPENDITURES AND SOCIAL POLICY IN THE UNITED STATES (1999) (tracing the 
histories of the home mortgage interest deduction, the earned income tax 
credit, the jobs tax credit, and tax benefits for employer pensions). 

52 See Victor Thuronyi, Tax Expenditures: A Reassessment, 1988 DUKE 
L.J. 1155, 1186–87 (1988) (defining tax expenditures as “substitutable tax 
provisions” that “can be replaced with a nontax-based federal program that 
fulfills the current tax provision’s purposes at least as effectively as does the 
current provision itself”). 



  

630 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

expenditures.53 Individual tax expenditures’ purpose weighs 
heavily in this analysis.54 

The idea of disguised spending implicates the structure of 
tax expenditures, many of which confer “upside-down 
subsidies” if structured as deductions in a system with 
progressive statutory rates.55 Consider a special deduction of 
$500 for all taxpayers.56 In a progressive rate structure, high-
income filers receive a greater dollar benefit than filers in 
lower tax brackets. For example, a marginal rate of 40% would 
generate a tax savings of $200, while a marginal rate of 22% 
would generate a tax savings of $110.57 High-income filers 
receive a greater dollar benefit for the same pretax economic 
outlay.58 This design contravenes policy norms that favor 
equal subsidies for comparable activities and progressive 
distributional outcomes.59 
 

53 This framing motivated parts of the Tax Reform Act of 1986, which, 
in part, limited tax expenditures to finance broad-based rate reductions. See 
Daniel Shaviro, Beyond Public Choice and Public Interest: A Study of the 
Legislative Process as Illustrated by Tax Legislation in the 1980s, 139 U. PA. 
L. REV. 1, 5 (“[T]he 1986 Act was the all-time leading example of tax 
reform.”). 

54 See Thuronyi, supra note 52, at 1197–98 (distinguishing tax 
expenditures’ “subsidy purpose” from “tax structure issues raised by the 
provision[s]”). 

55 See Surrey, supra note 1, at 722 (coining the terminology). See also 
Thuronyi, supra note 52, at 1159 (noting that Surrey’s characterization 
“shifts the focus of debate” by highlighting tax expenditures’ frequently 
“absurd” distributional implications). 

56 This example parallels the example in the text accompanying notes 
7–14, supra. 

57 These rates roughly reflect current law, which imposes a top marginal 
rate of 37%, plus a 3.8% net investment income tax, on the highest earners. 
See I.R.C. §§ 1, 1411. By contrast, a household with $80,000 of income 
(approximately the U.S. median for families) would face a marginal rate of 
22%. See Rev. Proc. 2023-34, § 3.01, 2023-48 I.R.B. 1287. 

58 For a deductible outlay, the tax subsidy is equal to the taxpayer’s 
marginal tax rate. 

59 Social policy considerations might favor upside-down subsidies, if, for 
example, high-income taxpayers made larger outlays that created outsized 
positive externalities. See Daniel J. Hemel, Phaseouts, 77 TAX L. REV. 53, 
79–83 (2023) (describing income-contingent externalities). Because these 
 



  

No. 2] TRANSFORMING TAX EXPENDITURES 631 

This structural interaction of tax benefits and progressive 
rates is compounded when high earners differ systematically 
from others across the income spectrum. High-income filers 
may have proportionately greater ability to finance tax 
benefits with debt.60 The home mortgage interest deduction, 
for example, varies directly with loan size and inversely with 
interest rates.61 To the extent that high-income filers’ loan size 
grows faster than any interest rate reductions, these filers 
benefit disproportionately compared to middle- and lower-
income taxpayers.62 Similarly, high-income filers may make 
larger outlays that are largely inframarginal—that is, those 
filers would make such outlays regardless of any tax-system 
subsidy. Under a deduction-based tax expenditure, these 
larger outlays cost the government more while generating a 
smaller public benefit, compared to middle- and lower-income 
taxpayers whose (smaller) outlays may lie at a behavioral 
margin. Environmental tax expenditures, such as benefits for 
electric vehicles, may function this way, in that lower-income 
taxpayers would not buy an electric vehicle, absent a 
subsidy.63 As with high-income filers’ enhanced ability to 
borrow, any subsidy would be even more upside-down than a 
deduction incurred evenly across the income spectrum. 

 
situations are likely unusual, tax deductions are not an appropriate default 
mechanic. 

60 This economic observation fuels debt-driven tax shelters. 
61 See I.R.C. § 163(h)(2). 
62 See Will Fisher & Chye-Ching Huang, Mortgage Interest Deduction Is 

Ripe for Reform, CTR. ON BUDGET & POL’Y PRIORITIES (June 25, 2013) 
(“Homeowners with higher incomes tend to have more expensive homes and 
thus more mortgage interest to deduct.”), 
https://www.cbpp.org/research/mortgage-interest-deduction-is-ripe-for-
reform. The Tax Cuts and Jobs Act increased the standard deduction, 
which, as a practical matter, eliminates most middle- and lower-income 
households’ home mortgage interest deduction. See id. 

63 Cf. Gilbert E. Metcalf, Using Tax Expenditures to Achieve Energy 
Policy Goals (Nat’l Bureau of Econ. Rsch., Working Paper No. 13753, 2008) 
(modeling ethanol credits), 
https://www.nber.org/system/files/working_papers/w13753/w13753.pdf 
[https://perma.cc/9VAA-87MX]. 



  

632 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

In this context, substantive modification is a viable reform 
strategy. Lawmakers can avoid the regressive aspects of tax 
expenditures by converting deductions to credits or otherwise 
capping benefits for high-income taxpayers.64 Comprehensive 
solutions are possible, such as alternative minimum taxes 
(AMTs) and overall limitations on itemized deductions. 
Notably, the corporate AMT and Pease limitation on itemized 
deductions both were repealed in 2017.65 Instead, the 
standard deduction was increased,66 which reduces the effects 
of tax expenditures in a way that arguably is regressive. 
Overall, these rationales do little to identify tax expenditures 
and have had limited effect in terms of eliminating the 
problem of upside-down subsidies. 

 
C. Base Expansion and Efficiency-Oriented Reform 
 
Another approach addresses tax expenditures from the 

perspective of comprehensive income taxation. This approach 
has two distinct phases. In the 1960s, Stanley Surrey, a 
preeminent tax lawyer, public servant, and academic, defined 
the term “tax expenditures” as avoidable deviations from an 
idealized construction of taxpayers’ income.67 The historical 
referent was economic income, defined in the Haig-Simons 
fashion as a taxpayer’s consumption and increase or decrease 

 
64 See Batchelder, Goldberg & Orszag, supra note 18, at 57 (arguing that 

refundable credits retain constant value “in the face of different earnings 
patterns and degrees of income volatility”); see also Hemel, supra note 59, 
at 5–6 (identifying situations in which phaseouts may prove efficient). 

65 See An Act to Provide for Reconciliation Pursuant to Titles II and V 
of the Concurrent Resolution on the Budget for Fiscal Year 2018, Pub. L. 
No. 115-97, §§ 11046, 12001, 131 Stat. 2054, 2088, 2092–94 (2017) 
[hereinafter Tax Cuts and Jobs Act]. 

66 See id. § 11021, 131 Stat. at 2072–73. 
67 In general, this definition of income was economic, with some 

concessions to custom and practicality. See John R. Brooks, The Definitions 
of Income, 71 TAX L. REV. 253, 274–78 (2018) (describing academic debates 
about the normative baseline against which tax expenditures are 
measured). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 633 

in wealth over a given period.68 This broad (and open-ended) 
definition fit within Supreme Court doctrine that emerged in 
the mid-1950s, which described income as including 
“undeniable accessions to [a taxpayer’s] wealth.”69 
Shepherded by Surrey, the nomenclature of tax expenditures 
emerged concurrently with a post-World War II shift towards 
base-broadening as a reform strategy.70 Again, this strategy 
implied tax expenditures’ repeal,71 since mere modification 
could not achieve comprehensive income taxation. From this 
perspective, lawmakers could reconstruct desirable 
preferences as explicit spending outside of the tax system.72 

Yale Law School professor Boris Bittker critiqued this 
approach—and a strategy of legislative repeal—by 
highlighting the conceptual and pragmatic challenges to 
implementing a truly comprehensive tax base. Bittker 
advocated incremental reform with a focus on distributional 
outcomes, as well as considerations such as administration 
and social policy. An idealized construction of income 
mattered less, or not at all. Too much judgment inhered in the 
construction of Haig-Simons income, and current law deviated 

 
68 See HENRY C. SIMONS, PERSONAL INCOME TAXATION 50 (1938) 

(“Personal income may be defined as the algebraic sum of (1) the market 
value of rights exercised in consumption and (2) the change in the value of 
the store of property rights between the beginning and end of the period in 
question.”); see also Robert M. Haig, THE CONCEPT OF INCOME—ECONOMIC 
AND LEGAL ASPECTS, in THE FEDERAL INCOME TAX 1, 7 (Robert M. Haig ed., 
1921), reprinted in Am. Econ. Ass’n, READINGS IN THE ECONOMICS OF 
TAXATION 54 (Richard A. Musgrave & Carl S. Shoup eds., 1959); Georg van 
Schanz, Der Einkommensbegriff und die Einkommensteuergesetze, 13 
FINANZ-ARCHIV 1, 1–87 (1896). 

69 See Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). 
70 See Brooks, supra note 67, at 270–71.  
71 See Shaviro, supra note 4, at 201 (arguing that the tax expenditure 

budget “was meant to serve as a hit list”). 
72 See Stanley S. Surrey & Paul R. McDaniel, The Tax Expenditure 

Concept: Current Developments and Emerging Issues, 20 B.C. L. REV. 225, 
255–56 (1979) (holding the repeal or reform of tax expenditures to the same 
standards applied to direct spending). 



  

634 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

too far from any reasonable metric of economic income.73 
Comprehensive income taxation was itself a political project.74 
Instead, Bittker advocated stepwise legislative change 
focused on pragmatic values instead of ideals.75 Although 
much legislation meets Bittker’s standard, Surrey’s approach, 
coupled with an efficiency-oriented economic analysis, has 
governed major tax reform since the 1980s. 

The dominant strand in recent tax reform efforts has 
revolved around the mantra of “broad base, low rates.” The 
intuition is that base-broadening reforms—typically, 
loophole-closing and the elimination of tax expenditures—
allow for generalized rate cuts under an assumption of 
constant revenue.76 In practice, lawmakers may set higher or 
lower revenue targets, then engage in base-broadening to 
obtain the lowest possible statutory rates under the new 
revenue constraint.77 Because the deadweight loss of taxation 
varies directly with the square of the effective tax rate 
imposed, lower rates minimize behavioral distortions while 
raising the desired amount of revenue.78 Under this construct, 
comprehensive income taxation is highly efficient. Because a 
comprehensive base has the broadest possible (or feasible) 
base, movements towards such a base enable the lowest and 
least distortionary marginal tax rates. This outcome 

 
73 See Bittker, supra note 2, at 933–34 (noting various incongruities and 

indeterminacies associated with an economic conception of a comprehensive 
tax base). 

74 See Shaviro, supra note 4, at 204–06 (noting the use of tax expenditure 
analysis “[a]s a weapon of political combat”). 

75 See Bittker, supra note 2, at 982–84 (“[W]e cannot avoid an 
examination of each [tax preference] on its merits in a discouragingly 
inconclusive process that can derive no significant assistance from a ‘no 
preference’ presumption [by reference to a comprehensive tax base].”). 

76 See Joel Slemrod, Is This Tax Reform, or Just Confusion?, 32 J. ECON. 
PERSP. 73, 74–75 (2018) (describing this type of reform in the Tax Reform 
Act of 1986). 

77 The budget reconciliation process, which avoids filibusters in the 
Senate, essentially requires Congress to establish a revenue target and then 
backfill taxing and spending measures to meet this target. 

78 See Hemel, supra note 59, at 77–78 (discussing the efficiency 
implications of phaseouts).  



  

No. 2] TRANSFORMING TAX EXPENDITURES 635 

simultaneously advances distributional goals, to the extent 
reflected in the statutory rate structure. Repealing or 
otherwise restricting tax expenditures is central to this 
project. 

 
D. Comparative Institutional Advantage 

 
A final perspective takes the policy implications of tax 

expenditures at face value, asking whether a particular 
government “program” (including revenue-raising functions) 
should be implemented through the tax system or another 
administrative vehicle. From this perspective, decisions about 
tax expenditures—existing or prospective—are “solely a 
matter of institutional design.”79 Efficiency remains the core 
criterion but is measured by administrative costs, rather than 
deadweight loss through peoples’ behavioral changes. 
Relevant factors include the degree to which administrative 
actors can coordinate or specialize in policy functions, the 
variations in agency costs across administrative actors, and 
the advantages of redundancy (or close complements) 
politically and in policy instruments.80 Reform proceeds 
holistically, with careful attention to the comparative 
advantages of various institutional actors.  

The concept of tax expenditures has little relevance to this 
process. Under Surrey’s theory of tax expenditures, programs’ 
content is (at least partially) endogenous with respect to 
 

79 See Weisbach & Nussim, supra note 27, at 957 (“The problem is 
similar to the problem of splitting up a corporation into divisions.”). 

80 See Nancy C. Staudt, Redundant Tax and Spending Programs, 100 
NW. L. REV. 1197, 1199–1201 (2006) (discussing the political and 
administrative advantages of redundancy); David A. Weisbach, Tax 
Expenditures, Principal-Agent Problems, and Redundancy, 84 WASH. U. L. 
REV. 1823, 1824–25 (2006) (discussing principal-agent and redundancy 
problems in the context of administrative specialization and coordination); 
see also Michael Doran, Legislative Organization and Administrative 
Redundancy, 91 B.U. L. REV. 1815, 1819–20 (2011) (locating the source of 
administrative redundancy in “the internal structures of Congress”); Blaine 
G. Saito, Context, Purpose, and Coordination in Taxation, 55 CONN. L. REV. 
375, 378 (2023) (applying “contextualized purpose” to better coordinate 
programs across administrative agencies). 



  

636 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

implementation, and tax expenditures tend towards 
structural features that undermine policy goals. From the 
perspective of institutional advantage, these structural 
features are administrative costs vis-à-vis a more abstract 
ideal policy. Defining the scope of programs and 
administrative actors also presents challenges, especially if 
programmatic topics are correlated with specific actors, 
politically or otherwise. This literature also speaks only 
indirectly to repeal efforts—the background assumption is 
that the underlying policy should exist—which is less relevant 
in the context of this Article. 

 
E. A Relational Definition of Tax Expenditures 

 
This Article deploys an alternative definition of tax 

expenditures that focuses on the relationship between the tax 
base and statutory rates—the crucial levers in effecting a 
base-rate transformation. For this purpose, “tax 
expenditures” include targeted provisions in the Code, the 
removal of which would allow for a reduction in generally 
applicable statutory tax rates, if revenues were held constant. 
The limitation to “targeted” provisions excludes broadly 
applicable provisions that compute net income, such as those 
that authorize business expense deductions.81 These 
provisions are not typically thought of as tax expenditures, 
and policymakers presumably would not repeal them 
wholesale.82 Portions of these provisions are, however, 
conventional tax expenditures with the social policy nexus 
often associated with such terminology.83 This Article draws 
examples from the canon of conventional tax expenditures 
while acknowledging the difficulties in a conceptual defense of 
this delineation. 

 
81 See, e.g., I.R.C. §§ 162, 163, 212. 
82 Cf. I.R.C. § 162(m) (denying deductions for certain executive 

compensation). 
83 See, e.g., I.R.C. §§ 162(f) (denying deductions for fines), 163(h) 

(denying deductions for personal interest other than home mortgage 
interest). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 637 

One advantage of this definition is that it focuses on the 
statutory construction of tax law, rather than policy or 
economic understandings of the tax system.84 That is, this 
definition does not rely on distinctions between structural and 
nonstructural legal provisions, or the identification of 
deviations from a normative baseline, or the substitutability 
of direct spending for tax relief. In addition, this definition 
emphasizes the relationship between the tax base and rates. 
For a given revenue constraint, the breadth of the legally 
defined tax base and statutory rates vary inversely, and 
movements in one variable implicate the opposite for the 
second. The fundamental relationships implicated by this 
relational definition of tax expenditures are explored in Part 
II. 

 
II. LAWMAKING AND THE BASE-RATE IDENTITY 

 
Tax revenue is the arithmetic product of two quantities, 

the tax base and applicable tax rates.85 From a conceptual 
perspective, the tax base comprises the assets, activities, or 
attributes subject to tax, while tax rates establish the share of 
the base payable to the government. In a progressive personal 
income tax, for example, the base is net income, and average 
rates rise as income increases.86 More mechanically, 
taxpayers determine their share of the base and the applicable 
rates for each period to which the tax applies, then remit the 

 
84 In this sense, this Article’s use of tax expenditures is the converse of 

the comparative institutional advantage school, which addresses tax 
expenditures only through their programmatic or policy aspects. As this 
Article demonstrates, a structural approach also yields insights. 

85 See Edward J. McCaffery, OXFORD INTRODUCTIONS TO U.S. LAW: 
INCOME TAX LAW 3 (2012) (“Any tax consists of the product of a base, or the 
‘what’ of taxation, and a rate structure, or the ‘how much’ of tax.”). More 
specifically, base and rate are integral to income taxes, consumption taxes, 
and ad valorem property taxes. Lump sum taxes (imposed uniformly on each 
taxable unit), excise taxes (imposed as a fixed amount per unit), and certain 
fees (to the extent they function like taxes) do not require value-oriented 
rates. 

86 Effective marginal and statutory rates also may be progressive. 



  

638 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

resulting product to the taxing authority.87 The sum of these 
remittances yields total government receipts.88 This “base-
rate identity”—that tax revenue equals taxpayers’ share of 
the tax base multiplied by their applicable rates—has legal, 
economic, and political implications.89 

 
87 Surrogates also may calculate and remit taxes on taxpayers’ behalf. 

For example, the United States’ income tax relies on self-reporting and 
voluntary payment backstopped by third-party information reporting and 
remittance. See Eric A. Posner, Law and Social Norms: The Case of Tax 
Compliance, 86 VA. L. REV. 1781, 1782 (2000) (arguing that tax compliance 
“contradicts the standard economic model of law enforcement”); see also 
Joshua D. Blank & Ari Glogower, The Tax Information Gap at the Top, 108 
IOWA L. REV. 1597, 1605 (2023) (“Tax information reporting plays a critical 
role in encouraging individuals to comply with the tax law and file their tax 
returns correctly.”). Similarly, taxes nominally imposed on one person may 
be designed to burden another in an economic sense. For example, 
individual holders of capital may bear all or part of the real incidence of 
corporate taxation, see Jennifer Gravelle, Corporate Tax Incidence: Review 
of General Equilibrium Estimates and Analysis, 66 NAT’L TAX J. 185 (2013), 
or employees may shoulder employer-side payroll taxes through a reduction 
in wages, see Dorian Carloni, Revisiting the Extent to Which Payroll Taxes 
Are Passed Through to Employees (Cong. Budget Off., Working Paper 2021-
06, 2021). These features do not change the fundamental computational 
mechanics of taxation. 

88 These mechanics do not account for costs incurred by the government 
to create and administer a tax instrument. See Shlomo Yitzhaki, A Note on 
Optimal Taxation and Administrative Costs, 69 AM. ECON. REV. 475, 476–
77 (1979). These public costs, as well as private-sector compliance and 
planning costs, have important implications for both the optimal scope of a 
tax base and the optimal rate structure. See David A. Weisbach, Ten Truths 
About Tax Shelters, 55 TAX L. REV. 232, 235 (2002). This Article generally 
uses tax revenue to describe the gross amount raised by a tax instrument. 

89 For example, lawmakers may establish a rate structure in light of the 
scope of the tax base. Thomas D. Griffith, Theories of Personal Deductions 
in the Income Tax, 40 HASTINGS L.J. 343, 360–63 (1989) (arguing that tax 
expenditures cannot be evaluated against the nominal rate structure, since 
“[i]t is more likely” that lawmakers “enact a rate structure with the 
understanding that its distributional impact will be modified by [tax 
expenditures]”). The base-rate identity can be expressed as: 

𝑅 =	∑ 𝑏! 	×	𝑟!"
!#$  , 

where R is total receipts, n is the total number of taxpayers, bt is a given 
taxpayer’s share of the base, and rt is that taxpayer’s applicable rate. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 639 

Policy debates, however, often obscure the mathematical 
relationship expressed by the base-rate identity in favor of 
heuristics about the economic implications of legal changes in 
the tax base and rates. Emblematic of these heuristics, for 
example, is the “broad base, low rates” approach to tax reform 
that emerged in the 1970s and 1980s—and that continues to 
influence today’s tax policy debates.90 To a significant extent, 
these heuristics muddy the boundaries between the legal and 
economic concepts expressed by this terminology. Just as 
commentators distinguish taxation’s nominal (or legal) 
incidence from its real (or economic) incidence,91 lawmakers 
should take care to differentiate tax rates and bases as 
nominally defined by law from those terms’ economic 
referents. This Part explicates—and argues for—a clearer 
delineation between the legal and economic definitions 
implicated by the base-rate identity. 

By divorcing nominal and real conceptions of the tax base 
and rates, an alternative perspective emerges. Although the 
tax base and rates have discrete conceptual and economic 
foundations, their practical application is more muddled. 
Policymakers and commentators deploy these terms in both 
positive and normative ways, and the interaction between 
these descriptive and prescriptive aspects has produced 
persistent controversy.92 Legal definitions of the tax base and 
 

90 See DEP’T OF THE TREAS., BLUEPRINTS FOR BASIC TAX REFORM 2 (1977) 
(describing model income and consumption tax plans that feature broad 
bases and low rates); 1 REPORT OF THE ROYAL COMMISSION ON TAXATION 9–
10, 15 (1966) (advocating comprehensive taxation based on “economic 
power” at lower marginal rates for individuals) [hereinafter CARTER COMM’N 
REP.]. For current approaches, see, e.g., ORG. FOR ECON. COOP. & DEV., 
CHOOSING A BROAD BASE-LOW RATE APPROACH TO TAXATION 11 (2010) (noting 
the prevalence, since 1980, of broad base-low rate tax reforms worldwide). 

91 See Sugin, supra note 6, at 20. 
92 See Shaviro, supra note 4, at 204–05 (“Tax expenditure analysis [ ] 

may have been viewed as a stalking horse for greater progressivity.”); see 
also Bittker, supra note 2, at 982–83 (“If I am right in asserting that most 
professed supporters of the [comprehensive tax base] concept favor a host of 
important departures from the Haig-Simons standard, there ought to be an 
equally drastic revision of their rhetoric, including a renunciation of the 
claim that we can or should eliminate all, or even most, “preferences” and 
“special provisions.”). 



  

640 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

rates have a mathematical fluidity that maps incompletely 
onto the terms’ economic understandings, and lawmakers 
already leverage this distinction to titrate policy outcomes.  

This Part first establishes the economic and legal aspects 
of tax bases and rates when constrained by a fixed revenue 
requirement. Then, this Part elaborates several examples of 
the base-rate identity as deployed by lawmakers, namely 
classified property taxes, capital gains preferences, 
depreciation recapture for real property, and the dividends 
received deduction. These disparate examples typically are 
not grouped together, but they emerge as a cognizable 
category when analyzed in the context of base-rate 
transformations, as developed further in Part III. 

 
A. Tax Bases, Rates, and Revenue Constraints 

 
The base-rate identity implies a fundamental 

mathematical relationship: holding tax revenue constant, the 
tax base and rates vary inversely. That is, for a given number 
of dollars needed to fund government—a public revenue 
constraint—a larger (or broader) tax base allows for 
proportionately lower rates, and a smaller (or narrower) tax 
base requires proportionately higher rates. This relationship 
between the tax base and tax rates has conceptual and 
practical implications in the design and reform of tax systems. 
Some of these implications flow from the economics of the 
base-rate relationship. Others are legal in nature, in the sense 
that they derive from the language and interpretation of the 
legislation enacting the tax. The relationship between these 
economic and legal implications is integral to reform efforts 
but also is frequently underspecified in those efforts.  

 
1. Economic Definitions 
 
Traditional tax policy analysis frequently begins with an 

ideal tax base and scrutinizes how various choices in the tax 



  

No. 2] TRANSFORMING TAX EXPENDITURES 641 

system affect this base.93 Then, the base is subjected to a rate 
structure—progressive, proportionate, or regressive—to 
produce revenue.94 In effect, this process moves through the 
base-rate identity stepwise, treating each operand as having 
independent significance. For decades, the distinction 
between the tax base and rates drove the questions asked by 
legal academics, economists, and policymakers. In the 1970s 
and 1980s, these questions (and their answers) coalesced in 
the political sphere as the “broad base, low rates” approach to 
tax reform.95 

This schematic emerged, in part, from early efforts to 
conceptualize economic income. For purposes of taxation, 
Henry Simons defined income as the sum of an individual’s 
consumption and net change in wealth over a specified time 
period.96 Simons leveraged this tautology—earnings are 
either spent or saved—to advocate for the equal inclusion of 
income from different sources, including income from 
capital.97 Although practical considerations tempered 
Simons’s holistic approach to the concept of income,98 his 
project was essentially base-broadening. Rates played a 
secondary role.99 

In the early 2000s, these approaches were supplemented 
by “sufficient statistics” methodologies in economics that test 
incremental policy adjustments with a focus on discrete 
changes in tax liability, rather than by reference to an ideal 

 
93 See, e.g., William D. Andrews, A Consumption-Type or Cash Flow 

Personal Income Tax, 87 HARV. L. REV. 1113, 1113–14 (1974). 
94 See, e.g., Joseph Bankman & Thomas Griffith, Social Welfare and the 

Rate Structure: A New Look at Progressive Taxation, 6 CAL. L. REV. 1905, 
1906 (1987). 

95 See DEP’T OF THE TREAS., supra note 90, at 53–54 (“[A] low-rate, broad-
base tax promises a general improvement in incentives.”). 

96 See SIMONS, supra note 68, at 50. 
97 See Brooks, supra note 67, at 276; see also Andrews supra note 93, at 

1123 (establishing rates after constructing “a cash flow, consumption-type” 
base). 

98 See Brooks, supra note 67, at 256, 269. 
99 See SIMONS, supra note 68, at 218 (advocating limited changes to the 

rate structure). 



  

642 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

tax base or optimal rate structure.100 This approach is 
compatible with analysis based on marginal costs and 
benefits,101 and it emphasizes that the tax base and rate 
structure sometimes are difficult to distinguish. Base-rate 
transformations track this literature, in that they focus on 
changes in tax due and effective marginal rates, rather than 
changes in the nominal base or nominal rates. In addition, 
base-rate transformations foreground the availability of 
incremental policy changes—along many axes—when 
implementing reform. 

 
2. Legal Definitions 
 
The base-rate identity implies that lawmakers can make 

trade-offs between the legal definitions of the tax base and tax 
rates under a revenue constraint without triggering the 
conventional economic consequences associated with such 
changes. As emphasized by the sufficient statistics movement 
in economics, the crucial variable for taxpayers’ behavior is 
their ultimate tax liability, as well as effective marginal rates 
(that is, how taxpayers’ tax liability changes with behavior). 
Legal definitions may or may not affect these variables. 

Consider a taxing authority that requires $1 million in tax 
revenue. If the relevant tax base is $5 million across all 
taxpayers, then average tax rates—again, across all 
taxpayers—must be 20%. Doubling the tax base to $10 million 
permits a halving of rates to 10%; conversely, halving the tax 
base to $2.5 million implies a doubling of rates to 40%.102 Each 
 

100 See Raj Chetty, Sufficient Statistics for Welfare Analysis: A Bridge 
Between Structural and Reduced-Form Methods, 1 ANN. REV. ECON. 451, 
452, 454 (2009); see also Dmitry Taubinsky & Alex Rees-Jones, Attention 
Variation and Welfare: Theory and Evidence from a Tax Salience 
Experiment, 85 REV. ECON. STUD. 2462, 2462–64 (2018). 

101 See David A. Weisbach, Daniel J. Hemel & Jennifer Nou, The 
Marginal Revenue Rule in Cost-Benefit Analysis, 160 TAX NOTES 1507, 1507 
(2018). 

102 See James Repetti, The Uneasy Case for a Comprehensive Tax Base 1, 14 
(B.C. L. Sch. Legal Stud. Rsch. Paper Ser. 99, 2006). Repetti points out that 
these rates are tax-inclusive, which is a typical formulation for income 
 



  

No. 2] TRANSFORMING TAX EXPENDITURES 643 

system raises the same amount of revenue. To the extent that 
these operations also apply to each taxpayer individually,103 
these taxes are homologous in their economic consequences. 
From a neoclassical perspective, none of these taxes affects 
behavior more or less than the others. Setting aside 
administrative costs,104 both alternatives impose the same 
real burden as the original tax, as well as the same marginal 
rates. 

Although the same economically, these three tax systems 
appear nominally different when complying with the tax 
reform mantra of “broad base, low rates.” Indeed, these 
changes could be strictly legal (or formal) in nature: 
lawmakers could finance a blanket 50% rate reduction by 
counting every dollar of current income twice, or a 50% rate 
increase by counting only half of each dollar of income. These 
numeric equivalencies underlie the idea of base-rate 
transformations. More formally, for any tax system with a 
legally defined base of B and rates of R, there are any number 
of alternative tax systems with bases of B′ and rates of R′ that 
impose the same economic burden as the initial tax system. 
The operation of these types of base-rate transformations is 
explored more concretely in Part III. 

 
B. The Base-Rate Identity in Action 

 
Lawmakers already leverage the base-rate identity to 

construct tax instruments. This Part illustrates the base-rate 
identity through several examples in which base adjustments 
are used to indirectly specify effective rates. These examples 
 
taxes. Id. The tax-exclusive rates—more relevant when calculating 
economic factors such as excess burden or deadweight loss—are 25%, 11.1%, 
and 66.7%, respectively. Id.; see also Andrews, supra note 93, at 1114 n.2, 
1119 n.10 (comparing tax-inclusive and tax-exclusive rates for income and 
cash-flow consumption taxes). 

103 That is, each taxpayer’s share of the base is doubled or halved, and 
their applicable rate receives the reverse treatment. 

104 In this example, the alternative systems impose incremental 
administrative costs of an entirely computational nature. These 
incremental costs are likely trivial. See Kathleen Delaney Thomas, The 
Psychic Cost of Tax Evasion, B.C. L. REV. 617, 617 (2015). 



  

644 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

involve classified property taxes; the preference for capital 
gains, including on sales of small business stock in § 1202; the 
intermediate rate applicable to the recapture of straight-line 
depreciation for real property; and adjustments to the 
corporate dividends received deduction in the Tax Cuts and 
Jobs Act of 2017 (TCJA).105 The mechanics of these diverse tax 
instruments are not typically grouped together, though they 
fit the same intellectual paradigm. The essential intuition is 
that base-rate transformations exist under current law, 
although they are not typically categorized as such. 

 
1. Classified Property Taxes 
 
State and local property taxes often use base adjustments 

as a substitute for explicit rate changes. After the tax revolts 
of the 1970s put downward pressure on revenue from real 
property taxes,106 states and localities adopted classification 
systems that imposed different tax burdens on different 
categories of real property. Typically, classification systems 
imposed higher tax burdens on commercial property, while 
residential and farming property faced lower burdens.107 
Sometimes, these systems operated within state 
constitutional limitations on tax rates or overall revenue. 
More generally, classification emerged as a common 
mechanism to titrate contributions to state and local revenue. 

Most states achieve classification by adjusting the tax 
base, as opposed to imposing different rates on real property. 
For example, in Colorado, the same nominal mill levy applies 
to all real property located within a taxing jurisdiction. Real 

 
105 Pub. L. No. 115-97, 131 Stat. 2054 (2017). 
106 See Ariel Jurow Kleiman, Tax Limits and the Future of Local 

Democracy, 113 HARV. L. REV. 1885, 1890–91 (2020) (arguing that 
participants in these tax revolts sought to increase public control over 
government as well as constrain tax revenue). 

107 See Nai Jia Lee & William C. Wheaton, Property Taxes Under 
“Classification”: Why Do Firms Pay More? 5 (Working Paper, 2010), 
https://economics.mit.edu/sites/default/files/2022-
09/Property%20Tax%20Under%20Classification-
%20why%20do%20firms%20pa.pdf [https://perma.cc/AW3M-GLDZ]. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 645 

property, however, is appraised at fair market value, then 
assigned an assessed value based on the property’s use. 
Residential property is assessed at approximately 7%, 
commercial and industrial property is assessed at 29%, and 
agricultural and certain renewable energy property are 
assessed at 26.4%. Oil and gas property is assessed at up to 
87.5%.108 After uniform millage rates are applied to each 
property classification, the result is a set of graduated 
effective rates based on use.109 

Base adjustments allocate control over property taxes 
across taxing jurisdictions, which can be numerous and 
overlapping in a given geographic area. States typically 
determine assessment ratios, while local taxing jurisdictions 
set millage rates annually in an administrative process.110 
These arrangements allow rates to fluctuate based on revenue 
need, while exacting the same relative contributions from 
each property classification. In addition, property tax 
limitations, such as millage rate caps, can apply at different 
levels—state, county, district, or city—with varying effects. 
This application of the base-rate identity allows for more 

 
108 COLO. REV. STAT. § 39 (2023); see Colo. Dept. Pub. Local Affairs, 

Chapter 6—Property Classification Guidelines and Assessment Percentages, 
https://arl.colorado.gov/chapter-6-property-classification-guidelines-and-
assessment-percentages [https://perma.cc/W7C6-GMS2]. Before 2020, the 
assessment percentages for residential and nonresidential real property 
were adjusted annually so that residential real property paid 45% of all 
property taxes (known as the Gallagher amendment). See S. Con. Rsch. 20-
001, 72d Gen. Assem., Reg. Sess. (Colo. 2020). Lawmakers also have 
adjusted assessment rates to provided targeted and temporary tax relief. 
See Sen. Bill 21-293, 73d Gen. Assem., Reg. Sess. (Colo. 2021), 
https://leg.colorado.gov/sites/default/files/2021a_293_signed.pdf 
[https://perma.cc/52U9-CL3N]. Other jurisdictions also use classified 
property tax systems. See Lee & Wheaton, supra note 107, at 4 (describing 
the growth in classified property taxes since 1913). 

109 Depending on incidence, these rates can be progressive or regressive. 
See Kleiman, supra note 106, at 1912 (discussing the incidence of property 
taxes across different groups, including renters). 

110 For large metropolitan areas, assessment ratios may be set by 
counties. See COOK CNTY., ILL. CODE OF ORDINANCES § 74-60 (2024), 
https://library.municode.com/il/cook_county/codes/code_of_ordinances 
[https://perma.cc/X3X7-RCTF]. 



  

646 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

nuance than platonic statutory definitions of bases and 
rates.111 

 
2. Capital Gains Preferences 
 
Between 1934 and 1986, Congress extended preferential 

rates to long-term capital gains through an exclusion, rather 
than explicitly lower statutory rates.112 That is, taxpayers 
included only a percentage of their long-term capital gains in 
their total taxable income, then paid tax on that income at 
statutory rates. Before 1942, the capital gains exclusion 
varied with holding period, with higher percentages for 
taxpayers who owned capital assets for longer. Between 1942 
and 1978, the exclusion was a flat 50%, with supplemental 
minimum taxes that applied after 1969. During this period, 
Congress effectively taxed long-term capital gains at half the 
rate of ordinary income; after 1965, the exclusion implied a 
rate of 35%, compared to a 70% top rate on ordinary income.113 
In 1978, Congress expanded the exclusion to 60%, which 
essentially reduced the rate for long-term capital gains to 
28%. In 1982, top rates on ordinary income fell to 50%, 
yielding another decrease in rates for long-term capital gains 
to 20%. Then, the Tax Reform Act of 1986 eliminated the 
exclusion for long-term capital gains and lowered top 
statutory rates to 28%.114 Subsequent changes have focused 
 

111 Simons noted this type of base-rate interplay, arguing that, in times 
of economic contraction, assessed values may exceed real values. A proper 
adjustment is to reduce rates. See SIMONS, supra note 68, at 33 n.20, 50. 

112 During this period, Congress sometimes subjected long-term capital 
gains to minimum taxes and maximum rates. See Gerald Auten, Capital 
Gains Taxation, in THE ENCYCLOPEDIA OF TAX’N & TAX POL’Y 58 (1999). 

113 When top marginal rates peaked at 94% in 1944, capital gains faced 
an implicit rate of 47%. See Tax Pol’y Ctr., Historical Highest Marginal 
Income Tax Rates, 1913 to 2023 (2023), 
https://taxpolicycenter.org/statistics/historical-highest-marginal-income-
tax-rates [https://perma.cc/V967-KUDX]. 

114 Pub. L. No. 99–514, §§ 101, 301, 100 Stat. 2085, 2096–99, 2216–17 
(1986). See Auten, supra note 112, at 58–59; James D. Gwartney & Randall 
G. Holcombe, Optimal Capital Gains Tax Policy: Lessons from the 1970s, 
1980s, and 1990s, JOINT ECON. COMM. 2–3 (1997).  



  

No. 2] TRANSFORMING TAX EXPENDITURES 647 

on statutory rates, rather than the interplay between an 
exclusion and rates.115 This history illustrates how Congress 
used nominal changes in the tax base and statutory rates to 
adjust the capital gains preference over time. 

Today, this strategy is evident in Congress’s revisions to 
§ 1202, the statutory exclusion for gain from the sale of 
qualified small business stock.116 When Congress enacted 
§ 1202 in 1993, the provision granted a 50% exclusion for 
gains from qualified small business stock. With a capital gains 
rate of 28%, the effective rate on such sales was 14%. When 
Congress lowered the general capital gains rate to 15% in 
2003, it kept the statutory rate applicable to qualified small 
business stock at 28%, which virtually eliminated the § 1202 
preference by reducing the rate advantage to a single 
percentage point—at least until Congress increased the 
exclusion to 100% after the Great Recession.117 This example 
shows how the base-rate identity can achieve something like 
de facto repeal for a tax preference. Just as base adjustments 
can change effective tax rates (as for long-term capital gains), 
rate adjustments can eliminate preferences embedded in the 
base. 

 
3. Depreciation Recapture for Real Property 
 
Fee ownership of improved real property consists of two 

distinct financial assets, land and improvements such as 
buildings. Under the Code, improvements are depreciable, 

 
115 Starting in 1990, Congress adjusted the capital gains preference 

through changes in statutory rates. See I.R.C. § 1(h); see also Federal 
Capital Gains Tax Rates 1988–2011, TAX FOUND. (2011), 
https://files.taxfoundation.org/legacy/docs/fed_capgains_taxrates-
20100830.pdf [https://perma.cc/Y5WD-6DTF]. 

116 I.R.C. § 1202. 
117 See generally Beckett G. Cantley, The New Section 1202 Tax-Free 

Business Sale: Congress Rewards Small Businesses That Survived the Great 
Recession, 17 FORDHAM J. CORP. & FIN. L. 1127, 1130–49 (2012) (tracing the 
history of I.R.C. § 1202). Congress implemented a temporary 75% exclusion 
for 2009 and 2010 before implementing a 100% exclusion. This temporary 
exclusion was an express stimulus measure. See id. at 1139–40. 



  

648 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

while land is not.118 Both assets may appreciate over time, 
however, and at different rates. Depreciation deductions 
generally reduce the owner’s ordinary income, while the sale 
of real property may produce long-term capital gain, if the 
owner holds the property for investment or in a trade or 
business.119 Recapture rules limit or eliminate this potential 
arbitrage involving rates, while recognizing that depreciation 
for tax purposes almost always exceeds the costs of actual 
wear and tear. 

On a sale of real property for gain,120 previously claimed 
straight-line depreciation is recaptured at a 25% rate.121 Any 
residual gain is taxable at the rates applicable to long-term 
capital gains, which are lower—20%—under current law. For 
example, if an owner claimed $1,000 of depreciation with 
respect to real property, the owner could reduce taxes due by 
$370 at a top marginal rate of 37%.122 If the owner sold that 
real property for a $2,000 gain, the owner would pay $250 in 
tax on the recaptured $1,000 of depreciation and $200 in tax 
on the remaining $1,000 gain, for a total of $450 in tax. 
Because the recapture rate for real property is 25%, the owner 
benefits from rate arbitrage (to the extent of $120) when 
claiming depreciation on real property.123 

One rationale for the hybrid 25% rate for depreciation 
recapture involves the difficulty in allocating the returns to 
improved real property among that property’s components, 
namely land and improvements. If land appreciates more 
rapidly than improvements, then gains with respect to real 
property predominantly reflect that appreciation. Because 
land is not depreciable, recapture of these gains does not 
 

118 See I.R.C. §§ 167, 168. 
119 See I.R.C. §§ 1221, 1231. 
120 See I.R.C. § 1001. 
121 See I.R.C. § 1(h)(1)(E), (6). Accelerated depreciation on real property, 

which is limited after 1986, is recaptured at ordinary income rates. See 
I.R.C. § 1250; see also I.R.C. § 168(e)(6) (defining qualified improvement 
property, for which limited expensing is allowable under current law). 

122 These rates do not account for taxes on net investment income. See 
I.R.C. § 1411 (imposing a 3.8% surtax on various types of passive income). 

123 The arbitrage benefit is equal to $370 minus $250. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 649 

address rate arbitrage. In the preceding example, if 75% of the 
owner’s $2,000 gain was attributable to the land, then only 
$500 of the gain reflects excess depreciation that warrants 
recapture. If the Code recaptured this depreciation at 
ordinary income rates, the owner would pay $300 in tax with 
respect to the land and $185 in tax with respect to the 
improvements. This total, $485, is roughly the amount 
payable under a flat 25% rate. The hybrid 25% recapture rate 
for real property makes sense because improved real property 
comprises both land and improvements, and these 
components have different economic characteristics.124 This 
example illustrates how an intermediate rate can 
compensate—incompletely and approximately—for a tax base 
that diverges from economic realities. 

 
4. The Dividends Received Deduction 
 
A final example involves changes to the dividends received 

deduction enacted by the TCJA in 2017. Before the TCJA, 
corporate tax rates generally were 35%, but corporations could 
deduct 70% or 80% of their dividend income as partial relief 
from three-level corporate taxation.125 Under these rules, 
corporations paid tax on dividends at effective rates of 10.5% 
and 7%.126 When the TCJA reduced corporate tax rates to 
21%, Congress also reduced the percentages for the dividends 
received deduction to 50% and 65%.127 These reductions 
maintained the effective rates on these intercompany 
dividends at 10.5% and (approximately) 7%.128 By modifying 
the tax base, Congress preserved proreform rates on certain 
types of transactions—a final example of lawmakers 
 

124 For a contrary view, see Richard L. Schmalbeck & Jay A. Soled, 
Unifying Depreciation Recapture, 48 CONN. L. REV. 531, 536 (2015) (arguing 
for recapture of depreciation on real property at full ordinary income rates). 

125 See I.R.C. § 243(a)(1), (c) (2017). 
126 These effective rates equal statutory rates, multiplied by one minus 

the deduction rate (that is, 35% × (1 – 70%) and 25% × (1 – 80%)). 
127 See I.R.C. § 243(a)(1), (c). 
128 The actual rate is 7.35%, which equals 21%, multiplied by one minus 

65%. 



  

650 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

leveraging the base-rate identity to achieve specific policy 
outcomes. 

 
III. TRANSFORMING TAX EXPENDITURES 

 
For targeted tax expenditures, base-rate transformations 

operate as a type of de facto repeal. This Part outlines the 
basic mechanics of base-rate transformations involving tax 
expenditures, as well as factors that affect whether 
lawmakers should consider this strategy for a given tax 
expenditure. Some tax expenditures may be more susceptible 
to base-rate transformations than others. 

Base-rate transformations involve two discrete 
components. The first step is a radical expansion of the subject 
provision’s scope, going from a narrow carve-out from the tax 
base to something approaching a universal benefit. This step 
eliminates the subject provision from the nominal tax base, as 
legally constructed. The second step requires correlative 
adjustments to statutory rates and rate brackets to forestall 
revenue loss and mitigate adverse distributional effects.129 
This step internalizes the subject provision as part of the 
statutory rate structure. Taken together, these steps leverage 
the base-rate identity to reconfigure legal definitions of the 
tax base and rates in a way that effectively eliminates the 
subject provision, in whole or in part, without the need for 
formal statutory repeal. 
 

A. Radical Expansion 
 
In a base-rate transformation, lawmakers eliminate a tax 

expenditure from the tax base by radically expanding the 
provision’s application—the converse of conventional 
statutory repeal. By definition, radical expansion narrows the 
nominal tax base, as established by law. Whether radical 
 

129 See GREG ESENWEIN, CONG. RSCH. SERV., REP. NO. RS22242, TAX 
REFORM AND THE GOAL OF REVENUE NEUTRALITY 3 (2005) (noting that 
revenue neutrality is, effectively, an assumption that allows comparison 
with repeal and restrictive reform options). Within this framework, repeal 
also requires potentially complex adjustments to the rate structure. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 651 

expansion affects the real (or economic) tax base depends on 
two factors: universal application and uniform benefits, each 
of which is explored below. 

To the extent that radical expansion achieves these 
criteria, lawmakers can mitigate—or even avoid—the 
economic costs of narrowing the nominal tax base by adjusting 
the statutory rate structure. If these criteria are not fully met, 
base-rate transformations will incur economic costs, though 
they still may improve on the status quo. In this sense, base-
rate transformations arbitrage the nominal-real distinction 
for the tax base and rates. 

 
1. Universal Application 
 
In the context of base-rate transformations, “universal 

application” refers to the proportion of taxpayers eligible for 
benefits under a particular tax expenditure. If 40% of 
taxpayers claim a specific statutory exemption, radical 
expansion would attempt to extend that exemption to all 
taxpayers. Tax expenditures, however, depend on behavior or 
status, which vary across taxpayers. One approach would 
treat these variations as trivial. For example, the child tax 
credit (CTC) applies only to taxpayers with one or more 
qualifying children.130 If Congress amended the CTC to 
conclusively presume that all households have at least one 
qualifying child, the CTC would apply universally and no 
longer would adjust taxpayers’ relative tax liabilities based on 
the actual size of their families.131 By unlinking taxation from 
reality, this change also would pressure definitions of the 
taxable unit and invite unintended errors and intentional tax 

 
130 See I.R.C. § 24. Treasury and JCT treat the CTC as a tax 

expenditure. See Off. of Tax Analysis, supra note 6, at 19; Staff of Joint 
Comm. on Tax’n, supra note 26, at 4 (each noting that the CTC serves as an 
adjustment for family size and structure). 

131 Similarly, decoupling the Earned Income Tax Credit from income 
requirements would transform that credit into a basic income grant. Cf. 
I.R.C. § 32 (requiring earned income to receive a tax benefit). 



  

652 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

gaming132—drawbacks that already exist to some extent 
under current law.133 This type of unlinking, however, would 
universalize access and potentially ameliorate disparities 
with respect to race and class.134 Although this route to 
universal application has significant implications for the 
CTC’s policy substance, this type of substance-agnostic reform 
is an option that remains open for lawmakers. 

Alternatively, radical expansion could occur along more 
substantive lines. Tax expenditures often target specific 
behaviors within a broader set of common economic or social 
activities, and universal application may proceed by 
generalizing the subject tax expenditure to this broader set. 
Consider the home mortgage interest deduction (HMID), 
which permits an itemized deduction for interest paid on up 
to $750,000 of mortgage debt incurred to buy, build, or 
substantially improve a taxpayer’s principal residence or 
vacation home.135 Although only some taxpayers borrow to 
acquire a principal residence,136 taxpayers overwhelmingly 
participate in the housing market in some capacity. For the 
 

132 For example, childless married individuals might divorce in order to 
double their credits for fictional children. See I.R.C. § 1 (stating rates for 
filing units). This type of gaming, of course, is possible under current law. 
See I.R.C. § 164 (imposing a marriage penalty for deducting state and local 
taxes). 

133 See Jacob Goldin & Ariel Jurow Kleiman, Whose Child is This? 
Improving Child-Claiming Rules in Safety-Net Programs, 131 YALE L.J. 
1719, 1725–27 (2022) (describing how child-claiming rules fail to 
accommodate the full range of family structures).  

134 See also Jacob Goldin & Katherine Michelmore, Who Benefits from 
the Child Tax Credit? 2 (Nat’l Bureau of Econ. Rsch., Working Paper No. 
27940, 2021) (finding “striking differences in patterns of CTC eligibility 
based on a child’s race), 
https://www.nber.org/system/files/working_papers/w27940/w27940.pdf 
[https://perma.cc/H9QY-7M2K]. 

135 See I.R.C. § 163(h)(3), (4). 
136 Of those who borrow to acquire a principal residence, even fewer 

claim the HMID as an itemized deduction. See Tax Pol’y Ctr., What Are 
Itemized Deductions and Who Claims Them?, TAX POL’Y BRIEFING BOOK 
(Jan. 2024) (noting that, after the TCJA, approximately 10% of households 
itemize deductions), https://taxpolicycenter.org/briefing-book/what-are-
itemized-deductions-and-who-claims-them [https://perma.cc/4CTF-8UBC]. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 653 

HMID, lawmakers could achieve universal application by 
giving a housing tax benefit to all households.137 Renters could 
deduct rent paid, and a formula-based housing deduction 
could be created for homeowners who do not itemize 
deductions or incur qualifying mortgage debt. This 
mechanism for radical expansion preserves the link between 
taxation and behavior, which may offer administrative 
advantages and restrain tax gaming. 

 
2. Uniform Benefits 
 
Radical expansion creates “uniform benefits” to the extent 

that taxpayers receive a common reduction in tax from the 
relevant tax expenditure. If a specific statutory exemption 
yields deductions for taxpayers that average $2,000 but range 
between $1,000 and $10,000, radical expansion could give 
each taxpayer a fixed deduction of $2,000, regardless of that 
taxpayer’s behavior or status.138 Alternatively, taxpayers 
could receive variable deductions based on a characteristic 
that appropriately figures into the rate structure. That is, the 
rate structure could be adjusted to “price out” the deduction. 
The most obvious characteristic is income, exclusive of the tax 
expenditure; other candidates could include family size, age, 
or geographic location.139 When undertaking radical 
expansion, uniformity simply requires that benefits 
correspond with statutory rates to produce a normatively 
desirable structure of effective and marginal rates. 

Just as for universal application, lawmakers have two 
routes to achieve uniform benefits. One route treats 
differences in behavior or status as trivial. The child and 
dependent care credit (CDCC) offers an example. The CDCC 
 

137 These benefits might incorporate an offset for (untaxed) imputed 
income, which is greater for taxpayers who own their homes debt-free. 

138 It is common to group taxpayers for purposes of distributional or 
other analysis. See Michael J. Graetz, Paint-By-Numbers Tax Lawmaking, 
95 COLUM. L. REV. 609, 640–41 (1995). 

139 Under current law, age and other life-cycle factors are not explicitly 
factored into the rate structure. There are, however, compelling reasons for 
doing so. See Fennell & Stark, supra note 21, at 2–3. 



  

654 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

provides a partially refundable credit equal to a variable 
percentage of the costs of market-based care, up to a fixed 
dollar amount.140 Take a two-earner household with one child 
that pays $4,000 for third-party childcare in 2024.141 Under 
current law, $3,000 of this household’s childcare costs are 
creditable at progressive rates between 20% and 35%.142 A 
radical expansion of the CDCC could impute creditable costs 
to otherwise-qualifying households that do not pay for 
market-based care, or that pay less than the maximum 
creditable costs for market-based care.143 Imagine a two-
earner household that pays $2,000 for occasional third-party 
childcare (and perhaps supplements with family care), and a 
single-earner household with one child, a stay-at-home 
caregiver, and no out-of-pocket childcare expenses.144 Under a 
radical expansion of the CDCC, both of these households could 
claim $2,000 in creditable costs.145 The CDCC transforms from 
a rebate for the costs of market-based care to an across-the-

 
140 See I.R.C. § 21. The American Rescue Plan Act of 2021 significantly 

expanded the CDCC for 2021 only, Pub. L. No. 117-2, § 9631, 135 Stat. 4, 
159–61 (2021), and subsequent legislative proposals would increase and 
modify the CDCC. See Margot Crandall-Hollick, More Can Be Done to 
Improve the Child and Dependent Care Credit, TAX POL’Y CTR. (Sept. 4, 
2024) (describing a bipartisan proposal to expand the CDCC), 
https://taxpolicycenter.org/taxvox/more-can-be-done-improve-child-and-
dependent-care-credit [https://perma.cc/QVP4-FEFL]. This discussion of 
§ 21 ignores coordination rules with employer-provided dependent care 
assistance programs. See I.R.C. §§ 21(c), 129. 

141 This analysis assumes that these expenses otherwise qualify for § 21. 
142 I.R.C. § 21(a)(2). The creditable rate declines as household income 

increases. A portion of the CDCC is refundable; in 2024, this amount was 
$1,700. Rev. Proc. 2023-34, § 3.05, 2023-48 I.R.B. 1287, 1291. 

143 This radical expansion treats household size as a component of the 
normative rate structure, rather than as a special adjustment to a 
normative tax base. But see Off. of Tax Analysis, supra note 6, at 19; Staff 
of Joint Comm. on Tax’n, supra note 26, at 4 (each taking the opposite 
position for purposes of constructing a normative baseline against which to 
measure tax expenditures). 

144 Bipartisan proposals for expanded “caregiver” tax benefits 
essentially operate under the principles of radical expansion. See, e.g., 
Credit for Caring Act of 2024, H.R. 7165, 118th Cong. § 2 (2024). 

145 Of course, these households might not receive the same credit.  



  

No. 2] TRANSFORMING TAX EXPENDITURES 655 

board rate adjustment based on family size and structure,146 
not unlike the CTC147 or the currently suspended personal 
exemption.148 Indeed, this example emphasizes how the idea 
of radical expansion reframes policy changes within the tax 
expenditure space. 

Uniform benefits also may have a substantive tether. 
Revisit the example of radical expansion of the HMID, in 
which universal application implies a basic housing tax 
benefit for all households. A fixed-dollar deduction—say, 
$6,000 annually for each household—would decouple this 
benefit from taxpayers’ actual housing costs and fully excise 
the HMID from the tax base.149 Alternatively, a variable-
dollar tax benefit also might have advantages. Because 
housing costs vary systemically across geographic regions and 
the urban-suburban-rural divide, a deduction based on actual 
housing-related outlays might improve equity (by taxing 
individuals on something closer to their real economic income) 
and efficiency (by making individuals indifferent to geography 
for tax purposes).150 But households’ housing costs also 
depend on taxpayers’ tastes and means—consumption 
preferences and income constraints that the tax system 
should take into account. For this reason, the uniformity 
criterion may require numeric caps, floors, or phaseouts (or 
 

146 Even though structured as a refundable credit, the CDCC can be 
viewed as an adjustment to the tax base—a partial exclusion for childcare 
costs. This adjustment may exceed filers’ total costs from childcare, 
although the credit’s limitations are much lower than average costs of full- 
or part-time childcare. See Adam Grundy, Estimated Revenue for Child Day 
Care Services Climbed as Child Care Options Declined in 2021, U.S. CENSUS 
BUREAU (Jan. 9, 2024) (finding that states’ average childcare costs ranged 
from $4,810 to $15,417 annually), 
https://www.census.gov/library/stories/2024/01/rising-child-care-cost.html 
[https://perma.cc/VK94-QAG9]. 

147 See I.R.C. § 24. 
148 See I.R.C. § 151(b)–(d). The TCJA suspended personal exemptions 

through 2025. See I.R.C. § 151(d)(5). 
149 For examples of statutory housing benefits, see I.R.C. §§ 107, 135, 

911. 
150 See generally David Abouy, The Unequal Geographic Burden of 

Federal Taxation, 117 J. POL. ECON. 635 (2009) (examining inefficiencies 
generated by not indexing tax liability based on local geographies). 



  

656 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

some combination of these limitations) on any cost-based 
housing tax preference.151 More generally, radical expansion 
may come with stipulations about the amount of benefits 
granted to various claimants—a typical strategy in tax 
expenditure reform.152 

 
3. Incomplete Expansion 
 
Political processes or other considerations may preclude an 

ideal radical expansion that achieves both universal 
application and uniform benefits.153 For the HMID, a housing 
benefit for all homeowners and renters may exclude the 
itinerant, the homeless, and those with nonmarket living 
arrangements. Similarly, politicians may prefer to give full 
CDCC benefits to households with cash costs for caregiving, 
leaving only a partial benefit for households with stay-at-
home caregivers. In these situations, the base-rate 
transformation cannot be complete, and the subject provision 
will not move out of the tax base—at least, not entirely. 
Something of the tax expenditure will remain. 

Repeal-seeking lawmakers should proceed with incomplete 
base-rate transformations, if the transformation improves on 
existing law and is not worse than other reform options. The 
relevant metric is the degree to which a radical expansion has 
universal application and creates uniform benefits.154 Any 
excess or deficiency leads to distortions. This analysis is 
complex, since radical expansions may—and are intended to—
affect (many) more taxpayers than just those who claimed the 

 
151 See, e.g., PAMELA J. JACKSON, CONG. RSCH. SERV., REP. NO. 7-5700, 

FUNDAMENTAL TAX REFORM: OPTIONS FOR THE MORTGAGE INTEREST 
DEDUCTION (2008). These caps and floors could be linked to geography and 
other factors. Cf. I.R.C. § 164(b)(5)(H) (allowing for the determination of 
sales tax deductions using tables). 

152 See generally David M. Schizer, Limiting Tax Expenditures, 68 TAX 
L. REV. 275, 321–42 (2015) (detailing seven types of limits on tax 
expenditures, including various types of caps, floors, and phaseouts). 

153 It also may be difficult to determine whether some benefits are, in 
fact, uniform. 

154 See supra Part III.A.1–2. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 657 

original tax expenditure. Benefits may shift in idiosyncratic 
ways, and distributional distortions may prove difficult or 
impossible to correct through the rate structure. 

For tax expenditures, a botched radical expansion carries 
greater potential risks than its converse, an incomplete 
repeal. Radical expansion and repeal are structural cousins: 
in this Article’s terminology, repeal could be described as 
“radical contraction.” Furthermore, repeal falls short when it 
does not apply universally, or when it fails to reduce all 
taxpayers’ benefits to a uniform value of zero. Grandfathering 
is a common example of incomplete repeal.155 Old claimants 
retain some or all of their tax benefits, while new potential 
claimants receive nothing. For tax expenditures, repeal risks 
only the revenue loss associated with the original provision. 
By contrast, radical expansion risks potential revenue loss 
from all new claimants.156 For this reason, risk-averse 
lawmakers may prefer to initiate base-rate transformations 
for tax expenditures that already apply broadly, with 
relatively small levels of benefits per taxpayer. Many large tax 
expenditures, such as the CTC, possess this characteristic.157 

 
B. Correlative Adjustments in Theory 

 
The second step in a base-rate transformation involves 

correlative adjustments to the statutory rate structure—tax 
brackets and nominal rates. This analysis assumes that, in 
addition to preserving effective marginal rates, lawmakers 
prioritize three other norms: revenue neutrality, 
distributional neutrality, and efficiency as expressed through 
taxpayers’ effective marginal rates.158 Revenue neutrality 
 

155 See Michael J. Graetz, Legal Transitions: The Case of Retroactivity 
in Income Tax Revision, 126 U. PA. L. REV. 47, 60–61 (1977). 

156 If 20% of the U.S. population claims a given tax expenditure, then 
radical expansion risks revenue loss associated with extending that tax 
expenditure to the remaining 80% of the U.S. population. 

157 See supra notes 130–134 and accompanying text. 
158 These norms grew to dominate tax reform discourse from the 1980s 

through the early 2000s. See PRESIDENT’S ADVISORY PANEL ON FED. TAX 
 



  

658 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

means that total government receipts remain constant, before 
and after reform. Distributional neutrality implies that the 
same individuals pay the same amount of tax, before and after 
reform.159 Efficiency refers to taxation’s effects on individuals’ 
marginal behavior. Each of these norms has a temporal 
component, in that government revenue, the distribution of 
tax burdens, and taxpayers’ incentives may change over time. 
And none of these norms is absolute. Lawmakers should 
deviate from revenue, distributional, and behavioral 
neutrality as normatively appropriate and politically 
expedient. 

This Section explores revenue neutrality, distributional 
neutrality, and effective marginal rates in the context of base-
rate transformations. Correlative adjustments to the rate 
structure are crucial in base-rate transformations, in that 
they illustrate the fundamental parallels between 
universalization and repeal for tax expenditures.160 In 
practice, lawmakers may not make these adjustments, or they 
may make these adjustments incompletely. But these 
adjustments are arithmetically possible across a wide range 
of radically expanded tax expenditures.161 Conventional 
repeal, of course, also implicates correlative rate adjustments 
within the analytic framework of revenue neutrality, 
 
REFORM, SIMPLE, FAIR, AND PRO-GROWTH: PROPOSALS TO FIX AMERICA’S TAX 
SYSTEM 42, 49 (2005) (discussing these norms in the context of tax reform 
involving multiple tax instruments); Shaviro, supra note 53, at 23–24 
(describing these norms with respect to the Tax Reform Act of 1986). More 
recently, the TCJA marked a clear departure from both norms—though the 
law also severely curtailed tax expenditures through the doubling of the 
standard deduction, which limited the number of filers who itemized 
deductions. See Slemrod, supra note 76, at 75, 87–90 (“[T]he Tax Cuts and 
Jobs Act was neither revenue neutral nor distributionally neutral, while the 
Tax Reform Act of 1986 was designed to be both.”). 

159 See Graetz, supra note 138, at 640–41. 
160 For an example of this process with respect to the repeal of tax 

expenditures, see TAX POL’Y CTR., THE TAX REFORM TRADEOFF: ELIMINATING 
TAX EXPENDITURES 2–4 (2017), 
https://www.urban.org/sites/default/files/publication/93201/2001499-the-
tax-reform-tradeoff-eliminating-tax-expenditures-reducing-rates_3.pdf 
[https://perma.cc/NR4H-Q3DH]. 

161 See infra Part III.C. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 659 

distributional neutrality, and efficiency. This Section 
contrasts the stakes of these adjustments in both the 
expansion and contraction context. 

 
1. Revenue Neutrality 
 
Radical expansion, the first step in base-rate 

transformations, narrows the nominal tax base. To maintain 
constant revenue before and after this change, nominal rates 
must increase—a fundamental application of the base-rate 
identity. This increase may entail more than numeric 
adjustments to statutory rates. Lawmakers may change 
stated bracket cutoffs or implicit zero-rate brackets, such as 
the exemption provided by the standard deduction.162 The 
range of tools to maintain revenue neutrality is substantial. 

In addition, lawmakers may treat revenue neutrality as 
more of a conceptual constraint than a practical one. The 
overall goal of legislation may be to raise revenue or enact tax 
cuts, and base-rate transformations simply provide 
information about reforms that maintain the tax system’s 
basic parameters. Alternatively (and more importantly), 
lawmakers may revisit the rate structure from the perspective 
of fundamental tax norms, such as equity and efficiency. Base-
rate transformations give a starting point for asking these 
normative questions. Finally, rate adjustments may map 
incompletely onto radical expansion for reasons of political 
economy. Expansion may be incomplete or uneven, and rate 
adjustments may fall short or exceed the values needed to 
maintain constant revenue. Each of these factors also applies 
to the conventional repeal of tax expenditures, though 
traditional tax expenditure analysis frequently omits these 
considerations. 

 

 
162 See I.R.C. § 63(a), (b)(1), (c). For examples of these adjustments, see 

infra Part III.C. 



  

660 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

2. Distributional Neutrality 
 
To some extent, the norm of distributional neutrality is in 

tension with a desire to repeal or reform tax expenditures. If 
some taxpayers benefit inappropriately from tax 
expenditures, those taxpayers should pay more, not the same, 
after reform. Still, the political economy of reform historically 
has favored maintaining taxpayers’ relative tax liabilities, 
then letting their post-reform behavior determine subsequent 
changes in tax liability.163 This type of distributional 
neutrality is hard to achieve when repealing or restricting tax 
expenditures, and it is similarly difficult to achieve in base-
rate transformations. 

A more-typical construction of distributional neutrality 
examines cohorts of taxpayers, rather than taxpayers as 
individuals. Divisions by income thresholds or quintiles or 
deciles are common.164 Base-rate transformations should be 
able to satisfy this version of distributional neutrality, which 
obscures intra-cohort variations.165 Because base-rate 
transformations adjust the generally applicable rate 
structure, taxpayers with the same income—however they 
arrive at that amount—should fare the same. 

More generally, the distributional effects of tax 
expenditure reform—through repeal or base-rate 
 

163 Cf. Graetz, supra note 138, at 648 (noting that, for the Tax Reform 
Act of 1986, “much of the tax increase for upper-income taxpayers was in 
the form of retroactive tax increases on pre-1986 tax shelter investments, 
[which] had only a temporary impact in increasing taxes of upper-income 
people, even though the provisions themselves, as well as the accompanying 
rate reductions, were permanent changes”). Tax reform also faces 
incremental legislative changes that can erode reform’s coherence. See 
Michael J. Graetz, Tax Reform Unraveling, 21 J. ECON. PERSP. 69, 70–72 
(2007) (describing the almost-immediate legislative pressure to unwind the 
Tax Reform Act of 1986). 

164 See Graetz, supra note 138, at 639–40 (noting that both types of 
divisions distort distributional analysis). 

165 See Graetz, supra note 138, at 639 (“Distinctions among families in 
the same income class are not captured in the distributional table even 
though in many instances intragroup differences may be more significant 
than intergroup differences.”). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 661 

transformations—depend on how correlative rate 
adjustments are made.166 To the extent that these 
adjustments are done at each income level (or by income 
cohorts), there are no distributional differences for either 
reform strategy. Concerns that relate to the construction and 
measurement of distributional outcomes exist for revenue-
neutral repeal as well as base-rate transformations. 

 
3. Efficiency 
 
Under a neoclassical approach, effective marginal tax rates 

affect individuals’ decision-making, particularly in the choice 
between incremental labor (which generates taxable income) 
and leisure (which is untaxed). Higher marginal rates reduce 
labor supply and generate deadweight loss, while lower 
marginal rates have the reverse effects. Although economists 
have challenged this conventional wisdom over the last two 
decades, effective marginal tax rates remain a material 
consideration when evaluating changes in law. 

The base-rate identity implies that changes to the nominal 
tax base can be offset exactly by correlative changes in the 
statutory rate structure, without affecting effective marginal 
tax rates. When making correlative adjustments for a base-
rate transformation, the objective is to identify changes to the 
rate structure that reverse the effects of radical expansion. In 
some cases, this task will be straightforward. For a tax 
expenditure that effectively becomes an additional standard 
deduction,167 the statutory standard deduction can be reduced 
by the same dollar amount as the effective additional 
standard deduction.168 Other situations require more complex 
solutions.169 If, for example, the HMID becomes a 

 
166 Distributional considerations may address wealth as well as income. 

See Sugin, supra note 6, at 7. 
167 See supra notes 130–134, 140–148 and accompanying text 

(discussing the CTC and CDCC). 
168 This reduction is subject to interactions with itemized deductions. 

See I.R.C. § 63(d). 
169 See infra Part III.C. 



  

662 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

geographically variable housing benefit, then the rate 
structure also must account for these geographic variations.170 

There is some tension between the desire to maintain 
effective marginal rates and the desire to maintain revenue 
neutrality. As a standard trope of “broad base, low rates” tax 
reform, revenue neutrality implies that repealing or limiting 
tax expenditures is efficient. Lawmakers can use the no-
longer-foregone revenue to finance statutory rate cuts, which 
reduce effective marginal rates for all taxpayers.171 For base-
rate transformations, radical expansion loses revenue, which 
lawmakers must make up by adjusting the statutory rate 
structure. This base-rate adjustment also must maintain pre-
reform effective marginal rates, which imposes an additional 
constraint. 

Finally, taxpayers’ behavior may diverge from neoclassical 
norms, perhaps because of behavioral psychology, salience, or 
fiscal illusion.172 Psychological considerations, such as loss 
aversion and the endowment effect, may affect how taxpayers 
view the elimination or expansion of a tax expenditure. 
Similarly, base changes may be more or less salient to 
taxpayers than changes in tax rates. Finally, “fiscal 
illusion”—the idea that people perceive different forms of 
government spending differently—may affect the political 
economy of repeal compared to base-rate transformations.173 
These factors do not point in a single direction or favor a single 

 
170 Doing so may be welfare-enhancing without regard to the base-rate 

transformation. See David Y. Albouy, The Unequal Burden of Federal 
Taxation (Nat’l Bur. of Econ. Rsch., Working Paper No. 13995, 2008) 
(modelling the effects of geographic cost-of-living variations and federal 
itemized deductions on taxpayers’ locational decisions), 
https://www.nber.org/system/files/working_papers/w13995/w13995.pdf 
[https://perma.cc/8C7X-D722]. 

171 This intuition may not hold when the lost tax benefit applies broadly 
and lowers those taxpayers’ marginal rates by more than the post-repeal 
across-the-board rate cut. 

172 See, e.g., David Gamage & Darien Shanske, Three Essays on Tax 
Salience: Market Salience and Political Salience, 65 TAX L. REV. 19, 20–21 
(2011) (distinguishing market salience from political salience). 

173 See id. at 24 (describing this well-traveled term as “emotion laden 
and potentially misleading”). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 663 

style of reform—and their effects may vary for different tax 
expenditures. For this reason, these factors are best 
considered within the context of specific legislative changes. 

 
C. Correlative Adjustments in Application 

 
In the tax expenditure context, base-rate transformations 

offer an alternative to statutory repeal or restrictive reform. 
Under certain conditions, base-rate transformations have the 
same distributional and efficiency consequences as these 
conventional reform options. This Section illustrates the 
equivalency between base-rate transformations and 
conventional reform options through a series of numeric 
examples that demonstrate an equivalence between repeal 
and base-rate transformations for hypothetical tax 
expenditures with various structures. In each example, most 
of the pressure is on correlative adjustments to reach 
equivalence. Each of these examples deploys a proxy for how 
a tax expenditure’s benefits are distributed across society, and 
these proxies, either alone or in combination, may reflect more 
complex distributions of tax expenditures under current law. 
In this way, the principles in this Section are adaptable across 
a range of tax expenditures. 

The examples in this Section use a baseline rate structure 
with a standard deduction (or zero bracket) of $10,000,174 a 
10% bracket for income from $10,001 to $20,000, a 20% 
bracket for income from $20,001 to $30,000, a 30% bracket for 
income from $30,001 to $40,000, and a 40% rate applicable to 
income of $40,001 and above. This statutory rate structure is 
progressive, in that rates apply to income within each band, 
regardless of the taxpayer’s total income.175 That is, taxpayers 
in each bracket pay a fixed amount of cumulative tax based on 
lower rate brackets, then a variable amount of tax based on 

 
174 These examples ignore itemized deductions and the standard 

deduction’s simplification purpose. See John R. Brooks, Doing Too Much: 
The Standard Deduction and the Conflict Between Progressivity and 
Simplification, 2 COLUM. J. TAX L. 203, 205 (2011). 

175 That is, higher earners benefit from each lower bracket. 



  

664 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

their income in their highest rate bracket. Table 1 illustrates 
this baseline rate structure. 

 
Tbl. 1: Baseline Rate Structure 
 

Bracket From To Marginal 
Rate 

Cumulative 
Tax 

Bracket 0 - $10,000 0% - 
Bracket 1 $10,001 $20,000 10% - 
Bracket 2 $20,001 $30,000 20% $1,000 
Bracket 3 $30,001 $40,000 30% $3,000 
Bracket 4 $40,001 - 40% $6,000 
 

Each example traces four hypothetical taxpayers: 
Individuals A and B, who each earn $15,000 of baseline 
taxable income, and Individuals C and D, who each earn 
$50,000 of baseline taxable income. Individuals B and D, 
however, claim tax expenditures that reduce their taxable 
income (and are subject to repeal). These hypothetical 
taxpayers are illustrative and represent lower- and higher-
income taxpayers, respectively. These examples also do not 
use the prechange revenue baseline as a revenue constraint. 
Instead, repeal raises revenue—as does the corresponding 
base-rate transformation. This (mild) relaxation of the 
constant revenue assumption focuses attention on correlative 
adjustments and relieves pressure on the intrinsically 
normative decision of how to adjust rates after a tax 
expenditure’s complete repeal.176 These adjustments would 
operate similarly under a constant prechange revenue 
constraint. 

 
1. Fixed-Dollar Benefits 
 
Some tax expenditures may be (or may approximate) fixed-

dollar benefits that apply to claimants across the income 
spectrum. An example is the CDCC, if claimants consistently 
 

176 See supra Part III.B. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 665 

spend more than the $3,000 credible maximum on eligible 
childcare costs.177 Consider the basic framework described in 
the Introduction: a tax expenditure in the form of a $500 
deduction claimed by some taxpayers, compared to no 
deduction in the absence of the preference. This fixed-dollar 
tax expenditure yields a $50 tax benefit for Individual B and 
a $200 tax benefit for Individual D, in each case compared to 
their nonclaimant counterparts, Individuals A and C.178 
Because Individual D benefits more than Individual B, this 
fixed-dollar benefit represents a classic upside-down subsidy. 
The full results for Individuals A, B, C, and D are in Table 2. 
 
Tbl. 2: Fixed-Dollar Tax Expenditure 
 
Individual Taxable 

Income Tax Due Average Tax 
Rate 

Individual A, 
Nonclaimant $15,000 $500 3.3% 

Individual B, 
Claimant $14,500 $450 3.0% 

Individual C, 
Nonclaimant $50,000 $10,000 20.0% 

Individual D, 
Claimant $49,500 $9,800 19.6% 

 
Repeal eliminates the $500 tax benefit and enforces the 

corresponding nonclaimant outcome on Individuals B and D. 
A base-rate transformation extends the $500 deduction to 
Individuals A and C, giving them the same benefit as 
prechange Individuals B and D. This expansion loses revenue, 
relative to repeal, and affects taxpayers’ marginal rates 
around the bracket cutoffs. Therefore, the statutory rate 
structure must change to accommodate radical expansion.  

 
177 See supra notes 140–148 and accompanying text. The educator 

expense deduction, capped at $300, serves as another example, see I.R.C. 
§ 62(a)(2)(D), as do benefits for electric vehicles, where taxpayers generally 
claim either zero dollars or the maximum benefit, see I.R.C. § 30D. 

178 The benefit is the deduction (or exclusion) of $500, multiplied by each 
individual’s marginal tax rate (10% and 40%, respectively). 



  

666 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

Because the deduction is fixed-dollar and universal, a 
corresponding reduction in all bracket cutoffs aligns 
taxpayers’ outcomes with repeal. That is, the standard 
deduction drops from $10,000 to $9,500, the 10% bracket 
spans $9,501 to $19,500, and so forth. After universalization, 
any tax expenditure with fixed-dollar (or effectively fixed-
dollar) benefits can be incorporated into the rate structure by 
reducing all bracket cutoffs by the fixed-dollar amount. Table 
3 shows the transformed rate structure for this example. 
 
Tbl. 3: Transformed Rates for Fixed-Dollar Tax Benefits 

 
Bracket From To Marginal 

Rate 
Cumulative 

Tax 
Bracket 0 - $9,500 0% - 
Bracket 1 $9,501 $19,500 10% - 
Bracket 2 $19,501 $29,500 20% $1,000 
Bracket 3 $29,501 $39,500 30% $3,000 
Bracket 4 $39,501 - 40% $6,000 
 

The base-rate transformation essentially produces the 
prechange claimant outcome in terms of taxable income, with 
the prechange nonclaimant result in terms of tax due and 
marginal rates. After this base-rate transformation, 
Individuals A and B each pay tax of $500 with a marginal tax 
rate of 10%, and Individuals C and D each pay tax of $10,000 
with a marginal rate of 40%. These bottom-line results are 
identical to repeal. The calculation of these results is different, 
however. Individuals A and B have taxable income of $14,500 
(compared to $15,000 under repeal), but Individual B’s 
standard deduction is $9,500—$500 less that the $10,000 
standard deduction under the repeal scenario. Similarly, 
Individuals C and D have taxable income of $49,500 with a 
$500 reduction in their standard deduction. Because the 
standard deduction is smaller, each bracket’s cutoffs are 



  

No. 2] TRANSFORMING TAX EXPENDITURES 667 

reduced by $500, leaving high-income individuals’ benefits 
from those lower rates unchanged.179 
 

2. Proportionate Benefits 
 

If tax expenditures vary in proportion to income, base-rate 
transformations require adjustments to statutory rates as 
well as bracket cutoffs. A real-world example of this type of 
tax expenditure is the TCJA’s well-known pass-through 
deduction in § 199A, which gives a 20% deduction with respect 
to certain types of business income.180 This Subsection 
considers a tax expenditure that produces a deduction equal 
to 5% of a taxpayer’s income.181 Individual B has a deduction 
of $750, while Individual D has a deduction of $2,500—three 
and a third times larger, which exactly reflects Individual D’s 
greater income. As taxpayers earn more, they claim a 
proportionately larger deduction in dollar terms. Individual 
D’s tax benefit of $1,000 reflects Individual D’s larger 
deduction as well as her higher marginal rate, compared to 
Individual B’s $75 tax benefit. From this perspective, 
proportionate tax expenditures provide a double upside-down 
benefit: higher earners receive a greater proportionate 
deduction as well as a greater proportionate tax benefit. Table 
4 shows full results for Individuals A, B, C, and D. 
 

 
179 See Jason S. Oh, Are Progressive Tax Rates Progressive Policy?, 92 

N.Y.U. LAW REV. 1909, 1973–74 (2017) (describing how intramarginal rate 
reductions can benefit high-earning taxpayers). 

180 For a fuller discussion of this provision, see infra Part V.C. 
181 A proportionate benefit could be progressive by varying inversely 

with taxpayers’ income. 



  

668 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

Tbl. 4: Proportionate-Benefit Tax Expenditure 
 

Individual Taxable 
Income Tax Due Average Tax 

Rate 
Individual A, 
Nonclaimant $15,000 $500 3.3% 

Individual B, 
Claimant $14,250 $425 2.8% 

Individual C, 
Nonclaimant $50,000 $10,000 20% 

Individual D, 
Claimant $47,500 $9,000 18.0% 

 
Repeal eliminates these tax benefits for Individuals B and 

D, restoring their tax outcomes to those of Individuals A and 
C, who pay $500 and $10,000 in tax, respectively. Expansion 
does the reverse, providing a 5% reduction in taxable incomes 
across all taxpayers and giving Individuals A and C the same 
pre-reform benefits as Individuals B and D. Again, to 
maintain revenue parity with repeal, the rate structure 
requires adjustment. 

In a base-rate transformation, this proportionate benefit 
requires two concurrent changes to the rate structure. First, 
bracket cutoffs must be reduced by 5% each. For example, the 
standard deduction falls from $10,000 to $9,500, and the 10% 
bracket extends to $19,000, rather than $20,000. Second, 
rates must be grossed up by 5%.182 After this gross-up, the top 
marginal rate rises from 40% to 42.11%. In each case, the 
magnitude of these changes reflects the proportionate tax 
benefit. The resultant rate structure is shown in Table 5. 

 

 
182 That is, rates must be multiplied by one divided by the difference 

between one and the proportionate benefit of 5%. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 669 

Tbl. 5: Transformed Rates for Proportionate Tax Benefits 
 
Bracket From To Rate Cumulative 

Tax 
Bracket 0 - $9,500 0% - 
Bracket 1 $9,501 $19,000 10.53% - 
Bracket 2 $19,001 $28,500 21.05% $1,000 
Bracket 3 $28,501 $38,000 31.58% $3,000 
Bracket 4 $38,001 - 42.11% $6,000 
 

Under a universal benefit and this rate structure, 
Individuals A and B pay $500 in tax, and Individuals C and D 
pay $10,000 in tax—exactly the same as if the tax expenditure 
were repealed. The computations differ. Individuals A and B 
have a nominal deduction of $750 and taxable income of 
$14,250, subject to slightly higher statutory rates. These 
individuals’ marginal rate remains 10%, since a one-dollar 
increase in real income yields a $0.95 statutory inclusion 
subject to a grossed-up statutory rate of 10.53% and an 
additional $0.10 of tax due. The effective rate on this next 
dollar of income remains 10%. Individuals C and D’s 
deduction is $2,500, making their taxable income $47,500. 
Although statutory rates are higher, effective marginal rates 
remain the same, since one dollar of real income produces a 
$0.95 statutory inclusion subject to a rate of 42.11%, or an 
additional $0.40 of tax due. Because this transformation 
adjusts brackets and rates simultaneously, marginal rates 
remain 10% for Individuals A and B and 40% for Individuals 
C and D. 

 
3. Regressive and Progressive Fixed-Dollar Benefits 
 
Fixed-dollar benefits also may be regressive or progressive 

with respect to claimants’ income, either in statutory 
construction or in effect. These more-complex patterns remain 
susceptible to base-rate transformations. Essentially, the 
point is that base-rate transformations can accommodate a 
broad range of fiscal topographies; the technique is closer to 



  

670 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

universal than niche. Consider, for example, a tax 
expenditure that either increases by $500 at $10,000 
increments (regressive) or decreases by $500 at $10,000 
increments (progressive). Table 6 describes this hypothetical 
tax expenditure. 

 
Tbl. 6: Variable Fixed-Dollar Tax Expenditures 
 

Income Regressive Tax 
Expenditure 

Progressive Tax 
Expenditure 

Up to $10,000 $500 deduction $2,500 deduction 
From $10,001 to 

$20,000 $1,000 deduction $2,000 deduction 

From $20,001 to 
$30,000 $1,500 deduction $1,500 deduction 

From $30,001 to 
$40,000 $2,000 deduction $1,000 deduction 

$40,001 and above $2,500 deduction $500 deduction 
 

For the regressive fixed-dollar tax expenditure, Individual 
B (in the 10% bracket) claims a fixed $1,000 deduction from 
income and a $100 tax benefit, while Individual D (in the 40% 
bracket) claims a fixed $2,500 deduction from income and a 
$1,000 tax benefit. Individuals A and C claim no tax benefits. 
Table 7 sets out these results. 
 
Tbl. 7: Regressive Fixed-Dollar Tax Expenditure 
 
Individual Taxable 

Income Tax Due Average Tax 
Rate 

Individual A, 
Nonclaimant $15,000 $500 3.3% 

Individual B, 
Claimant $14,000 $400 2.7% 

Individual C, 
Nonclaimant $50,000 $10,000 20% 

Individual D, 
Claimant $47,500 $9,000 18.0% 

 



  

No. 2] TRANSFORMING TAX EXPENDITURES 671 

Repeal eliminates these tax benefits and places 
Individuals B and D on par with Individuals A and C. By 
contrast, a base-rate transformation applies the results of 
Individuals B and D to Individuals A and C, then adjusts the 
rate structure to maintain revenue parity with repeal.183 
Again, two concurrent changes are required in this 
adjustment. First, bracket cutoffs must be adjusted 
downwards to account for the different tax benefits across 
income levels.184 The standard deduction (zero bracket) falls 
to $9,000 because of the $1,000 deduction claimed by all 10%-
bracket taxpayers, and, for the highest earners, the 40% 
bracket begins at $37,500 to account for those taxpayers’ 
$2,500 deductions. Other brackets are adjusted accordingly.  

Second, for higher-income brackets, the standard 
deduction also phases down, subjecting additional income to 
the 10% rate to smooth tax liabilities as high-earners’ 
deductions increase.185 Those earning in the erstwhile 20% 
bracket pay an additional $50 in tax, those earning in the 
former 30% bracket pay an additional $150 in tax, and those 
earning in the prior top bracket pay an additional $300 in tax, 
each deployed as a reduction in the standard deduction of 
$500, $1,500, and $3,000, respectively.186 These adjustments, 
 

183 The tax expenditures’ benefits remain as described in Table 6, even 
as bracket cutoffs are adjusted. 

184 These tax benefits remain tied to the income tiers described in Table 
6. 

185 This phase-down also could be accomplished through the direct 
addition of a flat dollar amount to those brackets’ tax due, or through an 
adjustment to the cutoffs for any submarginal bracket. Adjustments to the 
standard deduction are a relatively straightforward (and legislatively 
cognizable) mechanism to accomplish these results, but they are not the 
only mechanism. 

186 When, for example, individuals earn exactly $20,001 dollars, their 
tax expenditure deduction increases by $500 from $1,000 to $1,500 
(subjecting $500 less to the 10% rate, for a $50 tax savings), and their 
standard deduction decreases by $500 from $9,000 to $8,500 (subjecting an 
additional $500 to the 10% rate, for a $50 increase in tax due). At exactly 
$30,001 of pre-benefit income, individuals’ deductions increase by $500 
(with an additional tax benefit of $100 at a 20% rate), and their standard 
deduction decreases by an additional $1,000 to $7,500 (subjecting another 
 



  

672 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

based on changes in the regressive fixed-dollar tax 
expenditure, keep individuals’ tax liabilities the same as 
repeal without affecting marginal rates. Table 8 displays this 
rate structure. 
  

 
$1,000 to the 10% rate, for an additional $100 of tax due). The process 
continues at exactly $40,001 of pre-benefit income, where incremental tax 
benefits of $150 are offset by a tax detriment of $150 from subjecting an 
additional $1,500 of income to tax at a 10% rate. These offsetting 
mechanisms keep marginal rates identical across the conditions of repeal 
and base-rate transformations. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 673 

Tbl. 8: Transformed Rates for Regressive Fixed-Dollar 
Benefits 
 
Bracket From To Rate Cumulative 
Bracket 0 - $9,000 0% 0 
Bracket 1 $9,001 $18,500 10% 0 
Bracket 2 $18,501 $28,000 20% $950* 
Bracket 3 $28,001 $37,500 30% $2,850** 
Bracket 4 $37,501  40% $5,700*** 
* For taxpayers earning $20,001 to $30,000, Bracket Zero phases 
down to $8,500, and the Bracket 2 cumulative tax increases to 
$1,000. 
** For taxpayers earning $30,001 to $40,000, Bracket Zero phases 
down to $7,500, and the Bracket 3 cumulative tax increases to 
$3,000. 
*** For taxpayers earning $40,001 or more, Bracket Zero phases 
down to $6,000, and the Bracket 4 cumulative tax increases to 
$6,000. 
 

These two adjustments equalize marginal rates among 
taxpayers subject to repeal and the base-rate transformation. 
Individuals A and B have income of $14,000 after a $1,000 
deduction. Under the adjusted rate structure (with its lower 
standard deduction), Individuals A and B still pay $500 in tax 
and face a 10% marginal rate on additional income.187 
Individuals C and D have income of $47,500 after a $2,500 
deduction, and their tax due is $10,000 after accounting for 
lower cutoffs for each bracket, as well as the (further) reduced 
standard deduction for those in the 40% bracket. These 
taxpayers’ marginal rate remains 40%.188 

For progressive fixed-dollar tax expenditures, rate 
adjustments operate similarly, with bracket phase-ups to 
 

187 That is, Individuals A and B have tax due of $500 on $5,000 of income 
at a 10% rate in Bracket 1, with a 10% rate on their next dollar earned. 

188 That is, Individuals C and D pay a 40% rate on $10,000 of income in 
Bracket 4 ($4,000), plus $6,000 of tax due from lower brackets after the 
standard deduction phase-down. For these individuals, the next dollar 
earned faces a 40% tax rate. 



  

674 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

compensate for declining deductions under the tax 
expenditure. The progressive fixed-dollar tax expenditure in 
Table 6, for example, has a base-rate transformation as 
described in Table 9, with descriptive computations for 
Individuals A, B, C, and D similar to those described for 
regressive fixed-dollar benefits. 
 
Tbl. 9: Transformed Rates for Progressive Fixed-Dollar 
Benefits 
 
Bracket From To Rate Cumulative 
Bracket 0 - $8,000 0% 0 
Bracket 1 $8,001 $18,500 10% 0 
Bracket 2 $18,501 $29,000 20% $1,050* 
Bracket 3 $29,001 $39,500 30% $3,150** 
Bracket 4 $39,501  40% $6,300*** 
* For taxpayers earning $20,001 to $30,000, Bracket Zero phases up 
to $8,500, and the Bracket 2 cumulative tax decreases to $1,000. 
** For taxpayers earning $30,001 to $40,000, Bracket Zero phases 
up to $9,500, and the Bracket 3 cumulative tax decreases to $3,000. 
*** For taxpayers earning $40,001 or more, Bracket Zero phases up 
to $11,000, and the Bracket 4 cumulative tax decreases to $6,000. 

 
4. Regressive and Progressive Proportionate 

Benefits 
 
Finally, regressive or progressive tax expenditures may 

provide benefits in proportion to claimants’ income, either by 
statutory construction on in effect. Again, base-rate 
transformations work for these types of tax expenditures, and 
radical expansion can be equivalent to statutory repeal, 
depending on rate adjustments. This example deploys 
regressive and progressive proportionate benefits that range 
from zero to 20% of income, as set forth in Table 10. 
 



  

No. 2] TRANSFORMING TAX EXPENDITURES 675 

Tbl. 10: Variable Proportionate Tax Expenditures 
 

Income Regressive Tax 
Expenditure 

Progressive Tax 
Expenditure 

Up to $10,000 No deduction 20% deduction 
From $10,001 to 

$20,000 5% deduction 15% deduction 

From $20,001 to 
$30,000 10% deduction 10% deduction 

From $30,001 to 
$40,000 15% deduction 5% deduction 

$40,001 and above 20% deduction No deduction 
 

In this example, the regressive proportionate tax 
expenditure delivers a small tax benefit to Individual B, who 
has a $750 deduction (5% of Individual B’s $15,000 of income) 
and a tax benefit of $75 (at a rate of 10%), and a large tax 
benefit to Individual D, who has a $10,000 deduction (20% of 
Individual D’s $50,000 of income) and a tax benefit of $4,000 
(at a rate of 40%). These tax benefits are in comparison to 
Individuals A and C. Table 11 elaborates these numbers. 
 
Tbl. 11: Regressive Proportionate Tax Expenditure 
 

Individual Taxable 
Income Tax Due Average Tax 

Rate 
Individual A, 
Nonclaimant $15,000 $500 3.3% 

Individual B, 
Claimant $14,250 $425 2.8% 

Individual C, 
Nonclaimant $50,000 $10,000 20% 

Individual D, 
Claimant $40,000 $6,000 12.0% 

 
Repeal eliminates benefits for all claimants, with a 

strongly progressive effect; a base-rate transformation 
reaches the same outcome through different means. The 
proportionate tax expenditure applies to all taxpayers, rather 
than a subset. Then, this transformation requires three 



  

676 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

adjustments to the rate structure. First, bracket cutoffs are 
reduced to reflect the larger proportionate benefits as income 
increases, with high-rate brackets seeing a greater decrease. 
The standard deduction is reduced from $10,000 to $9,500 
based on the 10% bracket’s 5% proportionate deduction, while 
the 40% bracket begins at $32,000, rather than $40,000, 
which reflects the 40% bracket’s 20% proportionate deduction. 
These reductions apply to cutoffs for all brackets. 

In addition, statutory rates are grossed-up based on each 
bracket’s proportionate tax benefit, similar to the rate 
adjustments for flat proportionate-benefit tax expenditures. 
The 10% rate increases to 10.53% based on a 5% gross-up, 
while the 40% rate balloons to 50% under a 20% gross-up.189 
Intermediate rates are adjusted similarly. These grossed-up 
rates, combined with the relevant proportionate tax 
deduction, maintain marginal rates equal to the repeal 
scenario. 

Finally, the standard deduction phases down for higher 
brackets to allow for continuous tax liabilities across brackets. 
With respect to the prechange 20%, 30%, and 40% brackets, 
taxpayers pay an additional $105.26, $438.60, and $1,144.48, 
respectively. For the 40% bracket, the additional tax requires 
that the 10% bracket start at a negative value. This 
adjustment could be accomplished by adjusting other brackets 
to avoid a bracket that taxes phantom income. For 
computational consistency, this example retains a consistent 
adjustment to the standard deduction, which, in this example, 
requires a negative zero bracket for taxpayers in the highest 
statutory rate bracket. These three operations are collected 
into the rate structure in Table 12. 
 

 
189 That is, the 10% rate is multiplied by one divided by the difference 

between one and 5%, and the 40% rate is multiplied by one divided by the 
difference between one and 20%. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 677 

Tbl. 12: Transformed Rates for Regressive Proportionate 
Benefits 
 
Bracket From To Rate Cumulative 
Bracket 0 - $9,500 0% - 
Bracket 1 $9,501 $18,000 10.53% - 
Bracket 2 $18,001 $25,500 22.22% $894.74* 
Bracket 3 $25,501 $32,000 35.29% $2,561.40** 
Bracket 4 $32,001 - 50.00% $4,855.52*** 
** For taxpayers earning $20,001 to $30,000, Bracket Zero phases 
down to $8,500, and the Bracket 2 cumulative tax increases to 
$1,000. 
** For taxpayers earning $30,001 to $40,000, Bracket Zero phases 
down to $5,333.33, and the Bracket 3 cumulative tax increases to 
$3,000. 
*** For taxpayers earning $40,001 or more, Bracket Zero phases 
down to ($1,372.55) (that is, an additional $1,372.55 of “phantom” 
income, on top of regular taxable income, is taxed at 10%), and the 
Bracket 4 cumulative tax increases to $6,000. 
 

Progressive proportionate tax expenditures require 
comparable adjustments to the rate structure. For the 
progressive tax expenditure in Table 10, brackets are reduced, 
and rates increased, based on the proportionate tax benefit 
claimed at different income levels. The standard deduction 
phases up for filers with higher incomes, almost eclipsing the 
10% rate bracket for individuals in the 40% bracket. These 
results are described in the rate structure in Table 13. 
 
  



  

678 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

Tbl. 13: Transformed Rates for Progressive Proportionate 
Benefits 
 
Bracket From To Rate Cumulative 
Bracket 0 - $8,500 0% - 
Bracket 1 $8,501 $18,000 11.76% - 
Bracket 2 $18,001 $28,500 22.22% $1,117.65* 
Bracket 3 $28,501 $40,000 31.58% $3,450.98** 
Bracket 4 $40,001 - 40.00% $7,082.56*** 
* For taxpayers earning $20,001 to $30,000, Bracket Zero phases up 
to $9,500, and the Bracket 2 cumulative tax decreases to $1,000. 
** For taxpayers earning $30,001 to $40,000, Bracket Zero phases 
up to $12,333.33, and the Bracket 3 cumulative tax decreases to 
$3,000. 
*** For taxpayers earning $40,001 or more, Bracket Zero phases up 
to $17,701.75, and the Bracket 4 cumulative tax decreases to $6,000. 
 

Although stylized, these examples illustrate arithmetic 
(and algorithmic) strategies for adjusting the rate structure to 
complete a base-rate transformation after a tax expenditure 
is radically expanded. In these examples, the rate structure 
applies universally, which requires identical treatment of 
filers with the same taxable income, before the relevant tax 
expenditure. To the extent that tax expenditures vary 
significantly within a single income level, these types of rate-
structure transformations will result in differential treatment 
within the income level. These situations require more 
nuanced judgments about economic justice—something that 
base-rate transformations should force in any event.  

Similar arithmetic strategies apply to tax expenditures 
with more idiosyncratic distributions across the income 
spectrum, for which correlative adjustments may represent an 
exercise in ad hoc curve-fitting under a set of constraints and 
assumptions. In and outside of government, budget experts 
frequently perform this type of exercise for proposed changes 



  

No. 2] TRANSFORMING TAX EXPENDITURES 679 

in law.190 The process for base-rate transformations should 
proceed similarly. 

 
IV. POLICY CONSIDERATIONS 

 
As a reform strategy in the tax expenditure context, base-

rate transformations offer advantages and drawbacks 
compared to repeal or restrictive reform. This Part explores 
several (inexhaustive) factors that have implications for how 
lawmakers choose reform strategies. The framework for 
evaluation consists of the traditional tax policy norms of 
equity, efficiency, and simplicity; the overall takeaway is that 
substitutable instruments provide flexibility in reaching the 
most desirable policy outcome. When lawmakers can choose 
among equivalent legislative strategies, the likelihood of 
reaching appropriate outcomes increases, with different 
portfolios of risks should the chosen legislative strategy go 
awry. This strength is the principal reason to include base-
rate transformations among policymakers’ menu of potential 
reform options. 

 
A. Incomplete Rate Adjustments 

 
One risk of tax expenditure reform is that any rate 

adjustments will not be revenue neutral. The relevant inputs 
are whether rate adjustments undershoot or overshoot 
revenue neutrality (which primarily implicates efficiency), 
whether rate adjustments favor higher- or lower-earners 
(which primarily implicates distribution), and whether the 
subject tax expenditure provides progressive, proportionate, 
or regressive benefits with respect to taxpayers’ income (also 
relevant to distribution). This risk of incomplete rate 
adjustments applies to all strategies that address tax 

 
190 See, e.g., PRESIDENT’S ADVISORY PANEL ON FED. TAX REFORM, supra 

note 158, at 48–57 (walking through these processes in the context of reform 
based on income and consumption taxation). 



  

680 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

expenditures, including repeal, restrictive reform, and base-
rate transformations.191 

Rate adjustments undershoot revenue neutrality when tax 
increases are systematically too small and tax reductions too 
large for individuals at different positions in the income 
spectrum. In either case, total post-reform revenue is less 
than pre-reform revenue. Conversely, rate adjustments 
overshoot revenue neutrality when tax increases are 
consistently too large and tax reductions too small. As a 
result, total post-reform revenue is more than pre-reform 
revenue. Under either scenario, revenue differs before and 
after reform. 

While base-rate transformations require rate increases, 
revenue-neutral repeal requires rate reductions. Because of 
this directional difference, legislative bias in adjustments may 
differ for the two reform strategies. If, for example, rate 
increases generally are too small, while rate reductions are too 
large, then this bias makes the reform strategies more similar 
in terms of revenue effects.192 For both, legislative bias 
operates in the same direction—towards less revenue—and 
the empirical question is about magnitude. Although the 
scenario in which legislative bias operates in the same 
direction seems likely in practice, legislative bias could 
operate in opposite directions, which clearly would favor one 
strategy over the other. 

If this type of legislative bias operates differently across 
different income levels, then incomplete rate adjustments 
have distributional effects—and therefore implications for 
equity. These implications almost certainly affect the choice 
among strategies. If rate increases are relatively higher for 
high earners, then base-rate transformations are progressive; 
if rate cuts are relatively higher for high earners, then repeal 

 
191 Indeed, for repeal and restrictive reform, the risk of incomplete rate 

adjustments frequently is overlooked in advocacy to end or curtail specific 
tax expenditures. See supra notes 16–18 and accompanying text. 

192 These outcomes seem more likely in reform packages, rather than in 
isolated reforms. For isolated reforms, the likely risk is a failure to adjust 
rates at all, or a rate adjustment that is temporally separated from reform. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 681 

strategies are regressive. The converse has the reverse 
implications. 

The stakes of incomplete rate adjustments are magnified 
when a tax expenditure’s benefits vary across income levels. 
If a given tax expenditure is progressive, then repeal without 
full rate adjustments is regressive, while expansion is 
progressive. The reverse is true for regressive tax 
expenditures.193 Again, systematic biases in rate adjustments 
have significant policy implications. These biases also affect 
how repeal operates, and they implicate the choice between 
repeal and base-rate transformations. 

Setting aside empirical questions about how rate 
adjustments may fail (which may differ for various tax 
expenditures, as well as in terms of political economy), the 
point is that, in a world of incomplete rate adjustments, the 
choice of strategy—repeal, restrictive reform, or base-rate 
transformation—has bottom-line implications. These 
implications arise because each strategy involves an implicit 
or explicit decision about the appropriate statutory rate 
structure. 

 
B. Incomplete Expansion or Repeal 

 
Another risk of tax expenditure reform is that, if the 

legislature’s goal is repeal (or complete expansion), only 
partial repeal (or expansion) will be achieved. This result 
matters to the extent that rate adjustments are incomplete or 
misguided in light of partial repeal or expansion—so the 
precise stakes depend on how the rate structure changes, if at 
all, in connection with reform. If these risks are asymmetric 
between repeal and base-rate transformation, then one 
strategy is superior to the other.  

Grandfathering represents a special case of incomplete 
repeal that favors radical expansion. For tax expenditure 
reform, grandfathering involves granting pre-reform 

 
193 Longstanding conventional wisdom is that tax expenditures are 

largely regressive. See Surrey, supra note 1, at 721–22 (“[M]ost tax 
incentives have decidedly adverse effects on equity.”). 



  

682 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

recipients all or part of the tax expenditure’s value in the post-
reform period.194 If grandfathering is likely with respect to a 
tax expenditure, then base-rate transformations—which 
grandfather prior claimants while eliminating the practical 
and economic effects of such grandfathering—offer a 
compelling alternative to conventional repeal or restrictive 
reform. 

 
C. Simplicity 

 
Although conventional repeal removes a statutory 

provision while base-rate transformations expand the 
provision to all taxpayers, repeal is not clearly simpler than a 
base-rate transformation. Because the computational aspects 
of tax filings are mostly computerized (and if not 
computerized, then form-driven), any baroque math 
effectively can be hidden from taxpayers. Base-rate 
transformations, to the extent statutory language remains in 
the Code, risk adverse interactions with other aspects of 
income tax law. Proper drafting can avoid these interactions, 
but the risk for mistakes still exists.195 

 
D. Political Economy 

 
The political economy of repeal or restrictive reform for tax 

expenditures is potentially toxic.196 Avoiding this toxicity, 
 

194 For example, the TCJA reforms for the home mortgage interest 
deduction partially grandfathered existing home loans. See I.R.C. 
§ 163(h)(3)(F)(III) (grandfathering debt incurred before December 15, 2017, 
including debt refinanced after that date). 

195 See Sloan G. Speck, Structural Tax Reform and the Next REIT 
Revolution, 27 U. PA. J. BUS. L. (forthcoming 2025), U. Colo. L. Legal Stud. 
Rsch. Paper No. 25-2 (describing various risks of legislative noncoordination 
in tax law), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5100851 
[https://perma.cc/9XXJ-CMCV]. 

196 See Lawrence Zelenak, The Theory and Practice of Tax Reform, 105 
MICH. L. REV. 1133, 1145–47 (2007) (noting the political impediments to 
reform of the home mortgage interest deduction and tax benefits for health 
insurance). Although both of these topics were addressed by Congress 
 



  

No. 2] TRANSFORMING TAX EXPENDITURES 683 

which may exist because certain broadly applicable tax 
expenditures are particularly salient to taxpayers or 
legislators,197 is a principal motivator behind base-rate 
transformations. Base-rate transformations also may ease 
political economy considerations involving special interests 
and popular understandings of tax benefits. The idea that one 
reform strategy faces less legislative resistance is a core 
intuition behind lawmakers’ reasons to prefer tax 
expenditures in the first place. 

One countervailing factor is that rate adjustments may 
have more salience to taxpayers or legislators than changes to 
the base.198 That is, taxpayers or legislators may prefer to 
avoid rate increases and seek rate cuts, even if the effects of 
both policies are the same because of the equivalency between 
repeal and base-rate rate transformations. If so, the potential 
for revenue loss from base-rate transformations is significant 
and perhaps weighs against the strategy—and the analysis 
for incomplete rate adjustments would apply. 

 
 
subsequently, the resulting reforms did not meet the scope proposed by the 
President’s Advisory Panel on Federal Tax Reform in 2005. See Tax Cuts 
and Jobs Act, Pub. L. No. 115-97, § 11043, 131 Stat. 2054, 2086–87 (2017) 
(limiting prospectively the principal amount of a home mortgage that can 
yield deductible interest); Patient Protection and Affordable Care Act, Pub. 
L. No. 111-148, § 9001, 124 Stat. 119, 847–48 (2010) (imposing a prospective 
“Cadillac” tax, repealed in 2019 without ever taking effect, on certain high-
cost employer-sponsored health coverage). 

197 See Gamage & Shanske, supra note 172, at 51–53 (discussing market 
and political salience in the context of tax expenditures). Taxpayers’ 
experience and interaction with various taxes and tax benefits may make 
those benefits more or less salient. See Andrew T. Hayashi, The Legal 
Salience of Taxation, 81 U. CHI. L. REV. 1443, 1458–61 (2014) (discussing 
endogenous and exogenous sources of heterogeneity among taxpayers).  

198 See Gamage & Shanske, supra note 172, at 32–33 & n.58 (discussing 
the salience of average and marginal tax rates); Jacob Goldin & Yair 
Listokin, Tax Expenditure Salience, 16 AM. L. & ECON. REV. 144, 148 (2013) 
(finding that taxpayers systematically underestimate the subsidy rate 
associated with two base-adjusting tax expenditures, the charitable 
contribution deduction and the home mortgage interest deduction); Oh, 
supra note 10, at 1178 (finding that “the major tax expenditures,” among 
other “big moving pieces” of tax legislation, “have persistently been highly 
salient”). 



  

684 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

E. Expanding Options 
 
As policymaking strategies, repeal and substantive reform 

tend to promote binary or discrete outcomes. For a given 
provision, repeal implies either existence or nonexistence, 
while substantive reform may tend towards fixed bundles of 
policy provisions. The mechanics of base-rate transformations 
emphasize a continuous range of outcomes that allow for a 
greater degree of optimization under constraints, especially 
with regard to rates. Repeal can be viewed similarly—as 
radical contraction, instead of radical expansion.  

This approach to reform is compatible with the theory of 
the second best, which holds that, in an existing system with 
multiple parameters, optimizing a single parameter may not 
move the system towards a global (or even a local) optimum.199 
Instead, if one condition cannot be optimized, then deviations 
in other conditions are required to reach an outcome closer to 
optimal. Traditional repeal and substantive reform tend to 
elide these types of considerations, while base-rate 
transformations embrace them. 

 
V. BASE-RATE TRANSFORMATIONS IN ACTION 
 
This Part elaborates three case studies. The first case 

study is positive and traces the history of tax benefits for 
health insurance. The exclusion from income for employer-
paid health insurance premiums is a frequent target of tax 
expenditure reformers, but, over decades of incremental legal 
change, the expansion of this benefit beyond employees has 
resulted in an ad hoc base-rate transformation that 
essentially has integrated health insurance costs (which are 
variable) into the rate structure. 

The second case study addresses certain transfer 
payments (such as the Earned Income Tax Credit), standard 
 

199 See R.G. Lipsey & Kevin Lancaster, The General Theory of the Second 
Best, 24 REV. ECON. STUD. 11, 11 (1956); see also Richard S. Markovits, 
Second-Best Theory and Law & Economics: An Introduction, 73 CHI.-KENT 
L. REV. 3, 4–5 (1998) (discussing the implications of the theory of the second 
best for distributional outcomes). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 685 

deductions, and phaseouts for these benefits as fertile ground 
for base-rate transformations. Although nominally located in 
the tax base, these provisions are customarily thought to 
comprise part of the effective rate structure. The idea of base-
rate transformations unifies and reframes these disparate 
distribution-oriented provisions. 

The third case study involves the so-called “pass through 
deduction” under § 199A. Enacted in 2017, the pass-through 
deduction has attracted more opprobrium than virtually any 
other provision in the TCJA. A base-rate transformation 
would shed much of this provision’s complexity and 
inefficiency, while potentially remaining politically palatable. 
This case study illustrates the mechanics of base-rate 
transformations, as well as certain challenges that base-rate 
transformations face in implementation. 

 
A. Tax Expenditures for Health Insurance 

 
The exclusion from income for employer-provided health 

benefits, including employer-provided health insurance 
(EPHI), is projected to reduce federal tax revenue by almost 
$250 billion in fiscal year 2025—the largest single tax 
expenditure identified by JCT and Treasury in their 
respective reports.200 Economists and policy experts critique 
the EPHI exclusion as costly, inefficient, and undesirable from 
a distributional perspective,201 and commentators from across 
 

200 See Off. of Tax Analysis, supra note 6, at 25 ($246 billion); Staff of 
Joint Comm. on Tax’n, supra note 26, at 38 ($227 billion). For this exclusion, 
Treasury’s ten-year revenue cost estimate is more than $3.4 trillion. See 
Lawrence Zelenak, Giving Credit Where Credits Are (Arguably) Due: A Half 
Century's Evolution in the Design of Personal Tax Expenditures, 24 FLA. 
TAX. REV. 51, 81–82 (2020). 

201 For economists’ critiques, see generally Jonathan Gruber, The Tax 
Exclusion for Employer-Sponsored Health Insurance 1 (Nat’l Bureau of 
Econ. Rsch., Working Paper No. 15766, 2010) (“[E]conomists have for years 
advocated reform of this tax expenditure [for EPHI].”), 
https://www.nber.org/system/files/working_papers/w15766/w15766.pdf 
[https://perma.cc/5GQY-KMML]. See also David Powell, The Distortionary 
Effects of the Health Insurance Tax Exclusion, 5 AM. J. HEALTH ECON. 428, 
 



  

686 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

the political spectrum have called for the exclusion’s reform.202 
For example, Treasury and political advisors advocated 
curtailing or repealing the EPHI exclusion in connection with 
both the Patient Protection and Affordable Care Act (ACA) in 
2010 and the Tax Reform Act of 1986.203 Lawmakers rejected 
these proposals, and the EPHI exclusion has enjoyed more 

 
430–31 (2019) (finding, in a comprehensive analysis, that the exclusion for 
EPHI leads to annual deadweight loss of more than $13 billion). In addition, 
policy experts on the left and the right oppose the exclusion for EPHI. 
Compare Howard Gleckman, Congress Could Improve Both the Tax Code 
And Health Coverage By Redesigning The Tax Subsidy For Employer-
Sponsored Insurance, TAX POL’Y CTR. (Jan. 21, 2020), 
https://taxpolicycenter.org/taxvox/congress-could-improve-both-tax-code-
and-health-coverage-redesigning-tax-subsidy-employer 
[https://perma.cc/K2YZ-97PG], and Paul N. Van de Water, Limiting the Tax 
Exclusion for Employer-Sponsored Insurance Can Help Pay for Health 
Reform, CTR. ON BUDGET & POL’Y PRIORITIES (June 4, 2009), 
https://www.cbpp.org/sites/default/files/atoms/files/6-2-09health.pdf 
[https://perma.cc/8U3V-YAQ8], with Michael F. Cannon, End the Tax 
Exclusion for Employer-Sponsored Health Insurance, Pol’y Analysis No. 
928, CATO INST. (May 24, 2022), 
https://www.cato.org/sites/cato.org/files/2023-06/policy-analysis-928-
update.pdf [https://perma.cc/S7BH-UG7S], and Thomas P. Miller, Kill the 
Tax Exclusion for Health Insurance, NAT’L REV. (Aug. 19, 2014) (stating that 
Miller was a resident fellow at the American Enterprise Institute), 
https://www.nationalreview.com/2014/08/kill-tax-exclusion-health-
insurance-tom-miller. 

202 Compare Milton Friedman, How to Cure Health Care, HOOVER INST. 
(July 30, 2001) (arguing that the exclusion for EPHI “raise[s] health costs”), 
https://www.hoover.org/research/how-cure-health-care-0 
[https://perma.cc/DSE7-5UWV], with Jason Furman, Health Reform 
Through Tax Reform: A Primer, 27 HEALTH AFFAIRS 622, 631 (2008) 
(“Current tax expenditures for health care provide a pool of $200 billion that 
could be used to finance expanded or even universal coverage, with 
additional resources potentially left over for debt reduction or tax cuts.”). 

203 See DEP’T OF THE TREAS., 1 TAX REFORM FOR FAIRNESS, SIMPLICITY, 
AND ECONOMIC GROWTH ix (1984) (proposing a monthly dollar cap that would 
limit the exclusion for “only about 30 percent of all employees”), 
https://home.treasury.gov/system/files/131/Report-Tax-Reform-v1-1984.pdf 
[https://perma.cc/79XF-DW36]; Furman, supra note 202, at 629 (proposing, 
in the debate that led to the ACA, “[a]t a minimum, putting a cap on the 
existing exclusion [for EPHI]”). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 687 

than six decades of undisturbed tenure as a headline tax 
expenditure.204 

When considered in a broader context, however, the EPHI 
exclusion’s role has evolved dramatically over the last thirty-
five years. Through iterative changes in taxation and health 
care provisioning, Congress transformed the EPHI exclusion 
from a base carve-out into something more appropriately 
characterized as part of the rate structure. Congress 
accomplished this base-rate transformation indirectly, over 
time, and without an express intent to produce unified policy. 
Since 1986, the story of the EPHI exclusion is not one of 
stymied tax expenditure reform. A more appropriate 
narrative focuses on Congress’s uncoordinated actions to 
universalize an imperfect exclusion for health insurance 
costs—something more akin to an idiosyncratic expansion of 
the standard deduction to account for typical health care 
expenditures. This transformation has important 
implications for how policymakers conceptualize the EPHI in 
terms of costs and programmatic scope, as well as for the 
normative stakes of reform proposals. 

 
1. Transforming Health Insurance Taxation 

 
The EPHI’s base-rate transformation emerges by 

comparing the tax treatment of EPHI coverage with the 
regulatory evolution of nonemployee health insurance in the 
United States over the last four decades. The baseline 
consequences of EPHI coverage have remained constant since 
the 1954 recodification of the Code.205 For employees with 
EPHI, income does not include either the cost of premiums, 

 
204 See Zelenak, supra note 200, at 82 (“[T]he very absence of changes in 

the EPHI tax rules is in striking contrast with [statutory changes to other 
popular tax expenditures].”). In 1983, Congress repealed a limited exclusion 
for wage replacement payments during periods of disability or, before 1976, 
illness. See Social Security Act Amendments of 1983, Pub. L. No. 98-21, 
§ 122(b), 97 Stat. 65, 87 (1983) (repealing I.R.C. § 105(d)). The broader 
exclusion for employer-provided health insurance remained, however. 

205 See H.R. REP. No. 591-8300, at 54 (1954). 



  

688 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

whether paid by the employees or their employers,206 or the 
value of medical care conferred through this insurance.207 
Employees (and their family members) receive the benefits of 
health insurance but are not taxed on this benefit’s value. This 
type of employment-based health insurance coverage applies 
to approximately 55% of the U.S. population.208 

Before 1987, working nonemployees, such as independent 
contractors and certain business owners, did not receive a 
generalized tax benefit for the costs of personal and family 
health insurance.209 Instead, these individuals could claim an 
itemized deduction for their aggregate medical care costs, 
including health insurance premiums, in excess of a floor 
equal to 5% of adjusted gross income.210 Starting in the 1960s, 
this itemized deduction lost value for taxpayers relative to the 
longstanding EPHI exclusion,211 as health insurance plans 
began to include primary care and nonhospital benefits in 
addition to surgical and major medical care—and as the 
growth in national health care costs started to accelerate.212 

To establish some degree of parity between employees and 
the self-employed, the Tax Reform Act of 1986 introduced a 
 

206 I.R.C. § 106(a). Employers generally may deduct these premiums as 
compensation expense. See Treas. Reg. § 1.162-10(a). 

207 I.R.C. § 105(a), (b). 
208 See KATHERINE KEISLER-STARKEY & LISA N. BUNCH, U.S. CENSUS 

BUREAU, REP. NO. P60-284, HEALTH INSURANCE COVERAGE IN THE UNITED 
STATES: 2023, at 3 (2024) (finding employment-based health insurance to 
cover 53.7% of people in 2023 and 54.4% of people in 2022), 
https://www2.census.gov/library/publications/2024/demo/p60-284.pdf 
[https://perma.cc/NPM4-645D]. Since 2010, this percentage has fluctuated 
between 54% and 59%. In the late 1990s and early 2000s, this percentage 
was approximately 65%. See Matthew Rae, Daniel McDermott, Larry Levitt 
& Gary Claxton, Long-Term Trends in Employer-Based Coverage, 
PETERSON-KFF HEALTH SYSTEM TRACKER (Apr. 3. 
2020), https://www.healthsystemtracker.org/brief/long-term-trends-in-
employer-based-coverage [https://perma.cc/7FP7-KWSP]. 

209 See H.R. REP. NO. 99-841, vol. II, at 538 (1986) (Conf. Rep.). 
210 See id. (discussing § 213). The 1986 Act increased the floor to 7.5% of 

adjusted gross income (AGI). 
211 H.R. REP. NO. 84-423, at 5 (1972). 
212 See Rosemary Stevens, Health Care in the Early 1960s, 18 HEALTH 

CARE FIN. REV. 11, 19 (1996). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 689 

limited deduction for working nonemployees equal to 25% of 
the amounts paid for health insurance—half of the 50% 
benefit proposed in the Senate amendment to the House’s 
original bill.213 As first enacted, this already-anemic provision 
was scheduled to expire after 1989. Over the next decade, 
Congress extended the provision’s sunset four times214 and 
ultimately made the provision permanent in 1995.215 Between 
1995 and 1997, Congress revisited the amount of the 
deduction, increasing the deductible percentage to 30%, then 
80%, then 100%, phased in over a ten-year period. In 1998, 
Congress shortened the phase-in period to five years, with full 
deductibility for working nonemployees’ health insurance 
costs beginning in 2003.216 

After the changes initiated by Tax Reform Act of 1986, 
current law allows working nonemployees to deduct all 
amounts paid for health insurance,217 subject to various 
limitations,218 and these individuals’ income does not include 
the value of medical care provided by this insurance.219 
Working nonemployees take this deduction against gross 
income—above the line—rather than as an itemized 
deduction in lieu of the standard deduction.220 This deduction 
mechanic, coupled with the exclusion of insurance benefits, is 
equivalent to an exclusion for the cost of health insurance 

 
213 See H.R. REP. No. 99-841, vol. II, at 538–39. 
214 See Pub. L. No. 101-239, § 6202(b)(3)(A) (1989); Pub. L. No. 101-508, 

§ 11410(a) (1990); Pub. L. No. 102-227, § 110(a)(1) (1991); Pub. L. No. 103-
66, § 13174(a)(1) (1993). 

215 See Pub. L. No. 104-7, § 1(a) (1995). 
216 See Pub. L. No. 105-277, § 2002 (1998). 
217 This category includes partners in partnerships and 2-percent 

shareholders in S corporations. See I.R.C. § 162(l)(5). 
218 Two of these limitations have an anti-abuse focus; they permit a 

deduction only to the extent of income from the activity and prohibit a 
deduction for individuals otherwise eligible for employer-provided health 
insurance. I.R.C. § 162(l)(2)(A), (B). A third limitation disallows any 
deduction for self-employment tax purposes. I.R.C. § 162(l)(4). By contrast, 
the costs of EPHI are deductible for employment tax purposes. See I.R.C. 
§ 3121(a)(2)(A)–(B). 

219 See I.R.C. § 104(a)(3). 
220 See I.R.C. §§ 62(a), 63(b), 63(d). 



  

690 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

premiums,221 which places working nonemployees in an 
income tax position comparable to employees covered by 
EPHI.222 Across seventeen years and seven acts of 
Congress,223 lawmakers expanded the EPHI exclusion to 
working nonemployees.224 This benefit applies to 
approximately one-tenth of the U.S. population.225 

The Tax Reform Act of 1986 also codified the long-standing 
administrative exclusion from income for health insurance 
and medical benefits provided to active and retired members 
of the armed services and certain family members.226 
Although the EPHI exclusion could apply to some of these 
benefits, the separate statutory exclusion provides certainty 
with respect to unique aspects of military-facilitated health 
care, such as post-retirement rights to direct medical care 
through facilities operated by the U.S. Department of 

 
221 Both the EPHI exclusion and the self-employed health insurance 

deduction have the same effect on AGI. This structure is important for 
various limitations and phaseouts, such as contribution limits for Roth 
IRAs. See I.R.C. § 408A(c)(3). 

222 The two categories are treated differently for employment and self-
employment tax purposes. Cf. Small Business Jobs Act of 2010, Pub. L. No. 
111-240, § 2042, 124 Stat. 2504, 2560 (2010) (allowing such deductions for 
self-employment tax purposes for a one-year period in 2010); see generally 
Shu-Yi Oei & Diane M. Ring, Tax Law’s Workplace Shift, 100 B.U. L. REV. 
651, 674–77 (2020) (describing how employee and nonemployee workers are 
treated for healthcare incentives delivered through the tax system). 

223 This figure would be eight acts of Congress, when including the 
ministerial elimination of the phase-in schedule in 2010. See Health Care 
and Education Reconciliation Act of 2010, Pub. L. No. 111-152, § 1004(d)(2), 
124 Stat. 1029, 1035 (2010).  

224 Some self-employed individuals may be worse-off by virtue of the 
deduction’s interaction with other tax provisions, and the deduction may not 
be mandatory. See James Edward Maule, No Thanks, Uncle Sam, You Can 
Keep Your Tax Break, 31 SETON HALL LEGIS. J. 81, 85–86, 135–36 (2006). 

225 See KEISLER-STARKEY & BUNCH, supra note 208, at 3 (finding that 
10.2% of people in 2023, and 10.5% in 2022, have direct-purchase health 
insurance, including through ACA exchanges). Tax expenditure analysis 
estimates that this exclusion costs approximately $8 billion annually. See 
Off. of Tax Analysis, supra note 6, at 25. 

226 See I.R.C. § 134. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 691 

Veterans Affairs.227 Again, the result is commensurate with 
the baseline EPHI exclusion: beneficiaries are not taxable on 
the insurance value of, or the actual services received through, 
these arrangements.228 A small but significant percentage of 
the U.S. population—between 3% and 5% annually—is 
covered through military-based health care.229 

The rest of the U.S. population does not have health 
insurance through their employment relationship, self-
employment, or the military. For working-age individuals, 
however, the current policy landscape reflects the principles 
and norms of the EPHI exclusion. In 2010, the ACA enhanced 
EPHI by requiring certain large employers—with at least fifty 
full-time employees—to provide a standard health insurance 
package, subject to a penalty for noncompliance.230 In 
addition, the ACA introduced a tax credit to encourage certain 
small employers to provide health insurance to their 

 
227 See STAFF OF S. COMM. ON THE BUDGET, 110TH CONG., TAX 

EXPENDITURES: COMPENDIUM OF BACKGROUND MATERIAL ON INDIVIDUAL 
PROVISIONS 121–23 (Comm. Print. 2008) (outlining unique features of 
health care provided to members of the military and their dependents), 
https://www.congress.gov/105/cprt/SPRT52491/CPRT-105SPRT52491.pdf. 
[https://perma.cc/4JT9-6N6Y].  

228 See H.R. REP. NO. 99-841, vol. II, at 549 (1986) (Conf. Rep.). 
229 See KEISLER-STARKEY & BUNCH, supra note 208, at 5 (finding that, in 

2023, 2.4% of people have TRICARE and 1.9% of people have VA and 
CHAMPVA), https://www2.census.gov/library/publications/2024/demo/p60-
284.pdf [https://perma.cc/NPM4-645D]. 

230 See I.R.C. § 4980H; STAFF OF THE JOINT COMM. ON TAX’N, GEN. 
EXPLANATION OF THE REVENUE PROVISIONS OF THE “RECONCILIATION ACT OF 
2010,” AS AMENDED, IN COMBINATION WITH THE “PATIENT PROTECTION AND 
AFFORDABLE CARE ACT” 37–42 (March 2010) (giving context and mechanics 
for the employer mandate) [hereinafter, ACA BLUEBOOK], 
https://www.jct.gov/publications/2010/jcx-18-10; see also Daniel J. Hemel, 
Pooling and Unpooling in the Uber Economy, 2017 U. CHI. L. FORUM 265, 
269–70 (noting the prevalence of EPHI among these firms after the ACA). 



  

692 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

employees.231 These employer-oriented provisions sought to 
bring more individuals into the EPHI exclusion.232 

Of at least equal importance, the ACA made health 
insurance coverage more available and affordable to lower-
income households. The ACA encouraged states to expand 
Medicaid eligibility to households earning up to 133% of the 
federal poverty level,233 and, as of 2024, forty states and the 
District of Columbia had done so.234 Historically, Medicaid 
beneficiaries have excluded from income the full value of their 
insurance and benefits under the general welfare doctrine.235 
The effect is equivalent to the EPHI exclusion, except that 
beneficiaries’ putative income comes from the federal 
government rather than from employers. For this reason, the 
ACA’s Medicaid expansion brought more individuals into an 
 

231 See I.R.C. § 45R; ACA BLUEBOOK, supra note 230, at 26–30 (giving 
context and mechanics for the small business tax credit for EPHI). 

232 The provisions’ effectiveness is unclear. Compare Asako S. Moriya, 
Thomas M. Selden & Kosali I. Simon, Little Change Seen In Part-Time 
Employment as a Result of the Affordable Care Act, 35 HEALTH AFFAIRS 119, 
119 (2016) (finding limited evidence that firms substituted part-time for 
full-time employees to avoid offering the ACA’s employer mandate), with 
Casey B. Mulligan, The Employer Penalty, Voluntary Compliance, and the 
Size Distribution of Firms: Evidence from a Survey of Small Businesses, 34 
TAX POL’Y & ECON. 139, 164 (2020) (finding evidence that firms manipulate 
the fifty-employee threshold to avoid offering EPHI). See also David 
Gamage, Perverse Incentives Arising from the Tax Provisions of Healthcare 
Reform: Why Further Reforms Are Needed to Prevent Avoidable Costs to 
Low- and Moderate-Income Workers, 65 TAX L. REV. 669, 697–98 (2012) 
(describing the incentive effects of the penalty provisions in § 4980H(a) and 
(b)). 

233 See Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 542 (2012). 
234 See Laura Harker & Breanna Sharer, Medicaid Expansion: 

Frequently Asked Questions, CTR. ON BUDGET & POL’Y PRIORITIES (June 14, 
2024), https://www.cbpp.org/research/health/medicaid-expansion-
frequently-asked-questions-0. The remaining ten states have a coverage 
gap, estimated to affect 1.6 million people, between Medicaid recipients and 
households eligible for premium assistance credits under the ACA. See id. 

235 See Alice Abreu & Richard Greenstein, Defining Income, 11 FLA. TAX 
REV. 295, 308 (2011) (addressing various government transfer payments); 
see generally Jasper L. Cummings, Jr., The General Welfare Exclusion, 169 
TAX NOTES FED. 441 (Oct. 19, 2020) (surveying seventy-five years of I.R.S. 
rulings involving the general welfare doctrine and its antecedents). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 693 

EPHI-like regime. Medicaid covers between 15% and 20% of 
the U.S. population.236 

In another effort to reach lower-income households, the 
ACA established an individual mandate to purchase health 
insurance,237 as well as regulated state insurance 
marketplaces and progressive subsidies to defray the out-of-
pocket costs of standard health insurance.238 Under the ACA, 
households with incomes above the federal poverty level 
qualify for partial subsidies, delivered as refundable premium 
assistance tax credits, for health insurance purchased 
through an ACA marketplace.239 The American Rescue Plan 
Act of 2021 (ARPA) increased these subsidies across all 
income levels, including high-earning households, for a 
limited time period.240 For households with incomes up to 
150% of the federal poverty level, ARPA effectively eliminated 
any out-of-pocket cost for purchasing a benchmark health 
insurance plan—at least for two taxable years.241 Under 
ARPA, these households also experienced an EPHI-like 
regime, in that the premium assistance tax credits 
reimbursed taxpayers dollar-for-dollar for their out-of-pocket 
costs of health insurance, but the receipt of the credits 
 

236 See KEISLER-STARKEY & BUNCH, supra note 208, at 8. 
237 See I.R.C. § 5000A(a). Although the TCJA reduced the penalty for 

noncompliance to zero, the individual mandate remains on the books. See 
I.R.C. § 5000A(c)(3)(A). 

238 See I.R.C. § 36B. Self-employed individuals who receive the § 36B 
credit can deduct uncredited costs under § 162(l). Treas. Reg. § 1.162(l)-
1T(a)(1). 

239 These subsidies phase out for households with incomes above 400% 
of the federal poverty level. See I.R.C. § 36B(b)(3)(A)(i); see also Gamage, 
supra note 232, at 687–89 (noting that taxpayers are ineligible for these 
subsidies when “affordable” EPHI is available); Oei & Ring, supra note 222, 
at 676–77 (describing the interaction of these subsidies with employee 
status). The ACA also authorized cost-sharing payments to insurance 
companies that participated in these marketplaces. See 42 U.S.C. § 18071. 

240 Pub. L. No. 117-2, § 9661, 135 Stat. 4, 182–83 (2021) (expanding 
health insurance premium tax credits for 2021 and 2022). The Inflation 
Reduction Act of 2022, Pub. L. No. 117-169, § 12001, 136 Stat. 1818, 1905 
(2022), extended these enhanced credits through 2025. 

241 See American Rescue Plan Act of 2021, Pub. L. No. 117-2, § 9661, 135 
Stat. 4, 182–83 (2021). 



  

694 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

generated no taxable income. The outcome is identical to an 
exclusion from income equal to the value of the health 
insurance, and taxpayers also may exclude any benefits under 
this insurance.242 Approximately 3% to 4% of the U.S. 
population acquires health insurance through an ACA 
marketplace.243 

From a more holistic perspective, exclusion is the 
normative tax treatment for health insurance costs for 
working-age individuals, whether those individuals are 
employees, self-employed, current or former military 
personnel, or lower-income, and whether those individuals’ 
health insurance comes from employer plans, the government, 
or regulated private markets.244 This treatment emerged not 
from Congress’s explicit design, but rather from incremental 
changes cobbled together across multiple decades, inside and 
outside of tax policy’s traditional boundaries. There are, of 

 
242 See I.R.C. § 104(a)(3). 
243 See KEISLER-STARKEY & BUNCH, supra note 208, at 2 (finding that 

3.6% and 4.0% of people had marketplace coverage during 2022 and 2023, 
respectively). Tax expenditure analysis places the annual cost of these 
credits at approximately $10 to $15 billion. See Off. of Tax Analysis, supra 
note 6, at 25. 

244 For nonworking retired individuals, the tax treatment of health care 
benefits, such as Medicare, is beyond the scope of this Article. One can, 
however, construct an exclusion regime from the structure of Medicare and 
Social Security. Medicare Part A is premium-free and effectively excluded 
from taxable income. Medicare Parts B and D require premiums that are 
not deductible, unless the requirements of § 213 are met. See I.R.C. § 213(a), 
(d). Individuals who purchase Medicare Parts B and D, however, 
overwhelmingly receive Social Security payments, at least 15% of which are 
excluded from income. See I.R.C. § 86(a). For individuals with maximum 
benefits, the minimum Social Security exclusion still exceeds the annual 
cost of Medicare Part B and D premiums for most individuals. See 2024 
Medicare Parts A & B Premiums and Deductibles, CTR. FOR MEDICARE & 
MEDICARE SERV. (Oct. 12, 2023), https://www.cms.gov/newsroom/fact-
sheets/2024-medicare-parts-b-premiums-and-deductibles 
[https://perma.cc/2TR6-8F2L]. For this reason, the minimum excluded 
portion of Social Security payments can be viewed as a reasonable proxy for 
health insurance costs. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 695 

course, gaps in this pastiche.245 But the general effect is 
functionally similar to a zero-rate bracket, or an additional 
standard deduction, based on the value of taxpayers’ health 
insurance.246 The shift from an exceptional EPHI exclusion to 
a quasi-universal benefit for health insurance is a base-rate 
transformation—at least in part, since Congress made no 
explicit rate adjustments in response to this universalization. 
In 1954, Congress enacted a bespoke base carve-out for EPHI; 
by the 2020s, that provision had become part of a broad-based, 
systemic exclusion for health insurance costs. 

 
2. Health Insurance and Tax Expenditure Analysis 
 
By reframing the evolution of the EPHI exclusion as a 

base-rate transformation, this Section challenges 
conventional policy wisdom about tax benefits for health care, 
as well as narratives of reform involving those benefits. In 
terms of tax expenditure analysis, this reframing implies that 
tax expenditure budgets systematically overstate revenue 
losses attributable to health insurance tax benefits. Because 
these health insurance tax benefits principally have rate 
effects, these losses depend not just on a reference (or 
normative) tax base, but on a reference (or normative) rate 
structure. Individual rates have changed dramatically since 
1986, and these changes should be considered when 
evaluating the legal evolution of the EPHI exclusion and 
related benefits. 

This reframing also implies that questions of repeal or 
substantive reform for the EPHI exclusion are misguided. 
 

245 For example, approximately 10% of the working-age U.S. population 
does not carry health insurance. See KEISLER-STARKEY & BUNCH, supra note 
208, at 5 (finding, in 2023, that 10.9% of people from 19 to 64 years old were 
uninsured). 

246 See Brooks, supra note 174, at 219–20 (demonstrating the 
equivalence between a standard deduction and a zero bracket with a floor 
to claim personal deductions); Theodore P. Seto & Sande L. Buhai, Tax and 
Disability: Ability to Pay and the Taxation of Difference, 154 U. PA. L. REV. 
1053, 1143–44 (2006) (“The current zero-bracket is inadequate and not 
consistently implemented.”). Taxpayers can, of course, claim itemized 
deductions in addition to any benefits for health insurance. 



  

696 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

Instead, lawmakers should focus on identifying the 
components of health insurance benefits that apply 
universally and uniformly. Only health insurance benefits 
above or below these amounts require attention as 
components of the legal tax base. For example, lawmakers 
could revisit the ACA’s since-repealed “Cadillac tax” on high-
benefit health insurance plans.247 Lawmakers then should 
focus their attention on statutory rates, including the 
standard deduction. To the extent that the EPHI’s base-rate 
transformation did not appropriately address rates, those 
correlative adjustments should be made now. 

 
B. Standard Deductions and Demogrants 

 
A second case study considers the relationship between 

various tax and transfer programs designed to support low-
income filers.248 Specifically, standard deductions, 
demogrants, and phaseouts for these benefits help lawmakers 
achieve and enhance progressive rates across the income 
spectrum, including negative rates for low-earning taxpayers. 
The standard deduction is a fixed reduction in income 
available to all filers, while demogrants are universal cash 
transfers to all filers, regardless of need. Both types of benefits 
essentially create zero brackets for a fixed amount of economic 
income.249 Neither concept is implemented in the U.S. tax 
system in a pure form. Under current law, the standard 
deduction is replaced by itemized deductions (essentially, 
personal deductions and tax expenditures) for some filers,250 
while demogrant-like programs are limited by earnings from 

 
247 See supra note 196. 
248 For discussions of the merits of tax-based transfer programs, see 

Anne Alstott, The Earned Income Tax Credit and the Limitations of Tax-
Based Welfare Reform, 108 HARV. L. REV. 533 (1995); Weisbach & Nussim, 
supra note 27, at 1023–27. 

249 See Brooks, supra note 174, at 208 (arguing for the creation of a “true, 
independent” zero-bracket amount to separate “the progressivity and 
simplification purposes of the standard deduction”). 

250 See I.R.C. § 63.  



  

No. 2] TRANSFORMING TAX EXPENDITURES 697 

market labor, family size, and household income.251 These 
features are, essentially, phaseouts that increase 
progressivity at the cost of higher marginal rates—sometimes 
strikingly higher—for lower-income filers.252 

The progressivity implications of these instruments may 
not be salient to taxpayers. For example, in 1972, presidential 
candidate George McGovern proposed a refundable, universal 
tax credit of $1,000 per person, coupled with a flat nominal 
rate of approximately 33%. For a family of four, the credit 
would have offset exactly any tax due on $12,000 of income. 
Below that amount, the family would have received a net 
transfer from the federal government; above that amount, the 
family would have paid net income taxes to the government, 
increasing proportionately as the family’s income grew. 
McGovern’s opponent, Richard Nixon, had proposed several 
basic income plans similar to McGovern’s. By citing the 33% 
flat rate, however, Nixon successfully painted McGovern’s 
plan as a tax increase on lower-earning households. This 
example illustrates a “fiscal illusion” quality to the base-rate 
identity.253 

This case study shows the political perils of base-rate 
transformations when conducted explicitly. Nominal rates 
may prove more salient than base adjustments or explicit 
transfers. This outcome, however, should not preclude base-
rate transformations as a policy instrument—the political 
conversation may play out differently today than in 1972. 
Correlative rate adjustments through changes to bracket cut-
offs, including any zero brackets, may prove more favorable 
than nominal rate increases.254 And the type of implicit, 

 
251 See I.R.C. § 32.  
252 See Hemel, supra note 59, at 53–54 (noting that phaseouts increase 

taxpayers’ marginal rates indirectly, where Congress could achieve similar 
objectives through adjustments to the nominal rate structure). 

253 See supra notes 172–173 and accompanying text. 
254 The Carter Commission Report imposed a tax on income 

presumptively available for discretionary use, based on a schedule of 
assumed fractions of discretionary income at different income levels. Then, 
progressive rates were applied to this discretionary income. See CARTER 
 



  

698 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

longitudinal transformation evident in the exemption for 
health insurance premiums may prove even more favorable 
from a political economy perspective. 

 
C. The § 199A Pass-Through Deduction 

 
This Section provides a detailed case study of the 

mechanics and policy stakes of a hypothetical base-rate 
transformation involving the so-called “pass-through 
deduction” in § 199A of the Code. Enacted in December 2017 
as part of the TCJA, the pass-through deduction permits a 
limited deduction equal to 20% of a taxpayer’s business 
income for taxable years beginning before January 1, 2026. 
Few provisions of the first Trump Administration’s signature 
legislative achievement have attracted more opprobrium than 
the pass-through deduction. Academic commentators have 
identified myriad problems with § 199A,255 and a number of 
Democrats, including former President Biden, have advocated 

 
COMM’N REP., supra note 90, at 5–6; see also Boris I. Bittker, Income Tax 
Reform in Canada: The Report of the Royal Commission on Taxation, 35 U. 
CHI. L. REV. 637, 640–41 (1968). 

255 For academic commentary, see Alice G. Abreu, Tax 2018: Requiem 
for Ability to Pay, 51 LOY. L.A. L. REV. 61, 79–83 (2018); Karen C. Burke, 
Section 199A and Choice of Passthrough Entity, 72 TAX LAW. 551 (2019); 
Michael J. Graetz, Foreword: The 2017 Tax Cuts: How Polarized Politics 
Produced Precarious Policy, 128 YALE L.J. FORUM 315, 331–34 (2018); David 
Kamin et al., The Games They Will Play: Tax Games, Roadblocks, and 
Glitches Under the 2017 Tax Legislation, 103 MINN. L. REV. 1439 (2018); 
Daniel Shaviro, Evaluating the New US Pass-Through Rules, 1 BRIT. TAX 
REV. 49 (2018); Linda Sugin, The Social Meaning of the Tax Cuts and Jobs 
Act, 128 YALE L.J. FORUM 403, 415–16 (2018). For think-tank and policy-
oriented commentary, see Scott Greenberg, Reforming the Pass-Through 
Deduction, TAX FOUND. (June 21, 2018), 
https://taxfoundation.org/research/all/federal/reforming-pass-through-
deduction-199a; Edward Kleinbard, Op-Ed, Congress’ Worst Tax Idea Ever, 
THE HILL (Mar. 25, 2019), https://thehill.com/opinion/finance/434998-
congress-worst-tax-idea-ever; Alexandra Thornton, Broken Promises: More 
Special Interest Breaks and Loopholes Under the New Tax Law, CTR. AM. 
PROG. (Mar. 1, 2018), https://www.americanprogress.org/article/broken-
promises-special-interest-breaks-loopholes-new-tax-law. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 699 

eliminating or limiting the pass-through deduction—or 
allowing the provision to expire.256 

For opponents of § 199A, repeal, reform, and lapse through 
inaction face political and practical obstacles. To the extent 
that these obstacles prove intractable, this Section offers an 
alternative legislative blueprint: Congress could radically 
expand, rather than restrict, § 199A’s application.257 This 
expansion could shift the pass-through deduction from a base-
eroding provision to a generalized reduction in effective rates. 
Congress then could adjust statutory rates to forestall 
revenue loss and mitigate adverse distributional effects. The 
result is a base-rate transformation that aligns with 
traditional tax norms of equity, efficiency, and simplicity. 

This Part first elaborates the operation and application of 
the pass-through deduction under current law. Then, this 
Part advances arguments against conventional legislative 
approaches to repeal or reform in the context of § 199A. 
Finally, this Part discusses the specific statutory changes 
necessary to effect a base-rate transformation of the pass-
through deduction, as well as the stakes and sticking points 
of this particular transformation. The purpose of this analysis 
is not to advocate any single pathway for reforming § 199A, a 
project that is both necessary and important.258 Instead, this 
analysis further develops the menu of options available to 
policymakers in the reform process. 

This Article suggests that Congress cannot remedy 
§ 199A’s infirmities without addressing taxpayers across the 
 

256 Republicans generally favor revision or renewal of the pass-through 
deduction. See Andrew Lautz & Arianna Fano, The 2025 Tax Debate: The 
Corporate Tax Rate and Pass-Through Deduction, BIPARTISAN POL’Y CTR. 
(July 12, 2024), https://bipartisanpolicy.org/explainer/the-2025-tax-debate-
the-corporate-tax-rate-and-pass-through-deduction. 

257 But see Small Business Tax Fairness Act, S. 2387, 117th Cong. § 2 
(2021) (proposing various restrictions that would narrow the application of 
§ 199A). 

258 Although the second Trump Administration may advocate for 
extension of § 199A, this extension may require reforms to the provision. 
The challenges to reform described in this Part generally apply to Trump 
Administration efforts to extend sunsetting legislative policies from the 
TCJA. 



  

700 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

income distribution. Similarly, reforms that focus on § 199A’s 
restrictions, or guardrails, face the serious task of imbuing a 
hastily drafted and undertheorized tax preference with some 
sort of conceptual coherence. Better, instead, to look in the 
opposite direction: a radical expansion of § 199A to embrace 
more taxpayers, most notably those with wage income. This 
expansion would, in effect, transform § 199A into a permanent 
part of the progressive rate structure. Many of § 199A’s 
current guardrails could be eliminated, and statutory tax 
brackets could be adjusted—either contemporaneously or over 
time—to address distributional and revenue concerns. This 
base-rate transformation may have political advantages, and 
a carefully designed expansion may advance conventional tax 
policy norms such as equity, efficiency, and simplicity, 
without incurring additional revenue losses. 

 
1. What Is the Pass-Through Deduction? 
 
At the most fundamental level, the pass-through deduction 

allows individual taxpayers to deduct 20% of their qualified 
business income (QBI) from noncorporate business activities. 
The TCJA, however, layers a number of restrictions and 
guardrails on top of this basic computation—limitations on 
the provision’s top-line tax expenditure. To a significant 
extent, these limitations define § 199A’s policy contours. 
These limitations also introduce tremendous complexity in 
the provision’s implementation and application, and, more 
crucially, these limitations present meaningful obstacles to 
conventional reform. 

For all claimants, QBI is defined to include income and loss 
from a domestic qualified trade or business (QTB) conducted 
as a sole proprietorship or through a partnership or S 
corporation.259 The statute expressly precludes a deduction 
with respect to passive income items such as capital gains and 

 
259 QBI also includes qualified REIT dividends and qualified publicly 

traded partnership (PTP) income. See I.R.C. § 199A(b)(1). Because these 
items are exempt from most of § 199A’s limitations, they effectively 
represent a distinct tax benefit. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 701 

dividends.260 QBI also excludes income from personal services, 
namely wages from employment,261 reasonable compensation 
paid by an S corporation to a shareholder,262 guaranteed 
payments paid by a partnership to a partner in exchange for 
services,263 and other payments by a partnership to a partner, 
other than in the partner’s capacity as a partner, in exchange 
for services.264 Taken together, these service-oriented 
exclusions deny the § 199A deduction for income attributable 
to labor performed by a business owner, as contrasted to 
capital invested by the business owner or labor performed by 
nonowners. 

If a taxpayer has QBI from one or more QTBs in a taxable 
year, all items of QBI are netted.265 If this net amount is less 
than zero, there is no QBI for the year and no deduction under 
§ 199A. The deficit is treated as negative QBI in the 
succeeding taxable year.266 In effect, these loss accounting 
rules take a lifetime approach to tax benefits under § 199A, 
with the quirk that taxpayers’ lives for this purpose begin with 
the TCJA’s passage. For a given claimant, § 199A generates 
deductions only to the extent that the taxpayer has net 
positive QBI from all of the taxpayer’s QTBs, starting in 2018. 
This limitation is powerful, compared to a hypothetical 
alternative that tracks prior-year losses on a business-by-
business basis.267 Current law can penalize taxpayers with a 
portfolio of QTBs, especially if that portfolio is designed to 
 

260 I.R.C. § 199A(c)(3)(B). This paper ignores the preferences for 
qualified REIT dividends and qualified PTP income, which are broader and 
more straightforward than the preference for QBI. 

261 I.R.C. § 199A(d)(1)(B) (excluding “the trade or business of performing 
services as an employee” from the definition of a QTB). 

262 I.R.C. § 199A(c)(4)(A); Treas. Reg. § 1.199A-3(2)(ii)(h). 
263 I.R.C. § 199A(c)(4)(B). 
264 Treas. Reg. § 1.199A-3(b)(2)(ii)(J). 
265 Income from a QBI may be reduced for higher-income taxpayers. See 

infra notes 274–281 and accompanying text. 
266 I.R.C. § 199A(c)(2); Treas. Reg. § 1.199A-1(c)(2)(i). 
267 See Am. Bar Assn. Sec. Tax’n, Comments Concerning the Treatment of 

Losses and Certain Other Issues Regarding the Section 199A Deduction, 72 TAX 
LAW. 401, 405 (2019) (requesting guidance with respect to various issues 
involving losses under § 199A). 



  

702 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

match income and loss from various businesses on an annual 
basis to avoid current tax or the application of the passive 
activity loss rules.268 This category of claimants generally is 
higher-income. 

If a taxpayer’s net QBI amount is positive, a further global 
restriction applies to preclude certain double tax benefits. 
Mechanically, 20% of the taxpayer’s net QBI amount is 
compared to 20% of the taxpayer’s taxable income, after 
reduction for any net capital gain.269 The lesser of these two 
amounts is the taxpayer’s deduction under § 199A.270 For 
example, consider a taxpayer with $70,000 of net QBI, 
$30,000 of net capital gain, and $20,000 of itemized 
deductions. The taxpayer’s taxable income is $80,000.271 
Under § 199A, the taxpayer can claim a deduction equal to the 
lesser of $14,000 (20% of $70,000 of QBI) or $10,000 (20% of 
$50,000, the difference between $80,000 of taxable income and 
$30,000 of net capital gain). In effect, the statute disallows the 
taxpayer’s basic § 199A deduction to the extent of the 
taxpayer’s itemized deductions and net capital gain.272 These 
rules preclude taxpayers from benefiting from § 199A and 
preferential capital gains rates, the standard deduction, or 
itemized deductions with respect to the same dollar of taxable 
income.273 

Two further restrictions apply to taxpayers with taxable 
income over a threshold amount, which in 2024 was $191,950 
for individual filers and $383,900 for joint filers.274 These 
restrictions phase in ratably over the next $50,000 or 

 
268 Aggregation rules may mitigate some of this disadvantage. See 

Treas. Reg. § 1.199A-4(a) (treating each trade or business—a concept of 
uncertain scope—as separate unless permitted to be aggregated under 
specific rules). 

269 Net capital gain is taxable at preferential rates. See I.R.C. § 1(h). 
270 See I.R.C. § 199A(a). 
271 That is, $80,000 of QBI, plus $30,000 of net capital gain, minus 

$20,000 of itemized deductions. See I.R.C. § 63. 
272 The $4,000 reduction equals 20% of $20,000. 
273 The implicit ordering rule is that the standard or itemized deductions 

offset non-QBI ordinary income first, then QBI, then net capital gain. 
274 Rev. Proc. 2023-34, § 3.27, 2023-48 I.R.B. 1287, 1293. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 703 

$100,000 of income for individuals and joint filers, 
respectively. The first restriction excludes certain service-
oriented activities—specified service trades or businesses 
(SSTBs)—from the definition of a QTB, which means that 
these SSTBs do not generate a § 199A tax benefit for 
taxpayers with incomes over the threshold amount. The 
statutory list of SSTBs is cribbed from other parts of the Code 
and somewhat idiosyncratic in its coverage.275 For example, 
the provision of services in the fields of health, law, 
accounting, performing arts, consulting, and athletics are 
SSTBs, while the provision of engineering and architectural 
services are not SSTBs.276 One possible rationale for the SSTB 
limitation is that it supplements the income-independent 
service-oriented exclusions (for employees, for example) by 
categorically banning the § 199A deduction for enumerated 
activities that involve significant owner-provided labor.277 

The second restriction, known as the wage-basis 
limitation, caps the § 199A deduction based on characteristics 
of the QTB that generates QBI, namely employee wages paid 
by the QTB and the unadjusted basis immediately after 
acquisition (UBIA) of qualified property used in the QTB.278 
This process is complicated. First, negative QBI from any QTB 
is allocated among QTBs with positive QBI. Then, the portion 

 
275 To the extent that § 199A ameliorates the effect of lower corporate 

tax rates on choice-of-entity decisions, SSTBs may serve as a proxy for 
sectors that cannot easily incorporate and therefore are unaffected by rate 
disparities between corporate and noncorporate vehicles. See David A. 
Weisbach, Line Drawing Doctrine and Efficiency in the Tax Law, 84 
CORNELL L. REV. 1627, 1631 (1999) (noting the efficiency implications of 
legal distinctions between “substantially similar” arrangements). 

276 Engineering and architectural services could generate domestic 
production activities deductions under former § 199, which Congress 
repealed to enact § 199A. See I.R.C. § 199(c)(4)(A)(iii) (2017) (defining 
“domestic production gross receipts” to include “engineering or architectural 
services performed in the United States”). Successful lobbying by firms and 
professional associations preserved these fields’ special status in the 
transition to the pass-through deduction. 

277 Of course, activities not on the prohibited list also involve significant 
owner-provided labor. 

278 I.R.C. § 199A(b)(2)–(6). 



  

704 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

of the taxpayer’s § 199A deduction from each QTB is limited 
by the greater of 50% of the wages paid by the QTB or 25% of 
the wages paid by the QTB plus 2.5% of the QTB’s UBIA.279 
Wages and UBIA from QTBs with negative QBI, including 
carryforwards of prior years’ negative net QBI, are 
disregarded.280 This treatment of QTBs with negative QBI is 
not favorable for higher-income taxpayers, who are more 
likely to own interests in multiple QTBs. The wage-basis 
limitation can be rationalized as another restriction on 
returns to owners’ self-provided labor, much like the wage 
income and SSTB limitations. Essentially, the wage-basis 
limitation tests the QTB for returns to capital or employee-
provided labor.281 

Finally, § 199A does not apply in taxable years beginning 
after December 31, 2025. Many of the TCJA’s individual tax 
provisions carry a similar expiration date, while most of the 
TCJA’s corporate tax provisions continue until modified by 
Congress.282 Section 199A’s sunset clause reflects the 
exigencies of the budget reconciliation process through which 
Congress passed the TCJA.283 In addition, § 199A’s sunset 
 

279 The first prong also limited domestic production activities deductions 
under former § 199, and the second prong purportedly was added to secure 
the vote of Sen. Bob Corker. See Shaviro, supra note 255, at 50 (noting that 
Corker personally might save $1 million in taxes annually as a result of the 
UBIA allowance); see also Seung Min Kim, Why Corker Flipped on the Tax 
Bill, POLITICO, Dec. 18, 2017 (describing the UBIA allowance as the “Corker 
kickback”), https://www.politico.com/story/2017/12/18/bob-corker-tax-bill-
kickback-republicans-respond-302482. 

280 See Treas. Reg. § 1.199A-1(d)(2)(i). 
281 This rationalization unravels in various circumstances, such as those 

involving employee-owners of S corporations. See Amy E. Sheridan, 
Compensation and Benefits Aspects of the New QBI Deduction, 159 TAX 
NOTES 657, 657–59 (Apr. 30, 2018) (modelling how partners and S 
corporation shareholders can maximize § 199A benefits under statutory 
constraints). 

282 Compare I.R.C. § 1(j), with I.R.C. § 11(a). 
283 Specifically, legislation passed through the reconciliation process 

cannot increase deficits outside of the relevant temporal budget window. See 
Tax Pol’y Ctr., How Did the TCJA Affect the Federal Budget Outlook?, TAX 
POL’Y BRIEFING BOOK (Jan. 2024) (noting that extensions of the TCJA’s 
 



  

No. 2] TRANSFORMING TAX EXPENDITURES 705 

requires Congress to reconsider the provision, formally or 
informally, as the provision’s expiration date approaches.284 

 
2. Repeal, Lapse, and Reform 
 
The pass-through deduction’s opponents have three 

conventional legislative options to address § 199A, which 
seems likely to be extended in some form during the second 
Trump Administration. Congress could repeal § 199A, either 
entirely or only with respect to an income-defined subset of 
taxpayers. Alternatively, Congress could remedy § 199A’s 
infirmities through substantive reform, while maintaining the 
provision as a presumptively desirable tax expenditure. 
Partial repeal and substantive reform are not mutually 
exclusive. Finally, Congress could choose not to act, in which 
case § 199A would expire in 2026 according to the statute’s 
terms. Each of these three routes presents significant 
challenges. 

Full repeal seems unlikely, either in this Congress or 
future Congresses. Republican lawmakers generally support 
§ 199A in some form, and, during the Biden Administration’s 
first year, Democrats tabled political platform planks that 
promised complete repeal. For example, in the 2020 general 
election, then-candidate Joe Biden proposed eliminating the 
pass-through deduction for individuals earning more than 
$400,000 per year285—a relatively small proportion of total 
claimants, but a very significant proportion of total tax 
benefits.286 Although Biden Administration spokespeople 
 
sunsetting provisions would increase revenue loss beyond the budget 
window), https://taxpolicycenter.org/briefing-book/how-did-tcja-affect-
federal-budget-outlook [https://perma.cc/XQ5N-QRVU]. 

284 See Jacob E. Gersen, Temporary Legislation, 74 U. CHI. L. REV. 247, 
248 (2007) (elaborating how legislative sunsets “allocate[] agenda control 
and decisionmaking authority between current- and future-period 
majorities in Congress”). 

285 See Libin Zhang, Biden’s Proposed Tax Increases in Simple and 
Multivariate Charts, 171 TAX NOTES 703, 706 (May 3, 2021). 

286 See Lucas Goodman, Katherine Lim, Bruce Sacerdote & Andrew 
Whitten, Simulating the 199A Deduction for Pass-Through Owners 14, 16 
 



  

706 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

mentioned this limitation as late as March 2021, the 
Administration’s 2022 Greenbook, which details the effects of 
presidential revenue proposals, omitted any mention of the 
pass-through deduction.287 As the provision’s 2026 sunset 
approaches, myriad proposals would extend all or part of 
§ 199A, perhaps as part of a political compromise over the 
competing principles expressed in the first Trump 
Administration’s TCJA and the Biden Administration’s 
ARPA, which broadened certain social support programs on a 
temporary basis.288 Alternatively, the second Trump 
Administration could work with both Republican-controlled 
houses of Congress to extend § 199A through partisan 
legislation. 

Indeed, the pass-through deduction was never particularly 
likely to sunset quietly at the end of 2025. In the tax 
legislative process, sunset provisions are notoriously plastic, 
as evidenced by the longstanding congressional practice of 
renewing annually a class of expiring provisions known as 
“extenders.”289 Also, in 2001 and 2003, the Bush 

 
(Off. of Tax Analysis, Working Paper No. 118, 2019), 
https://home.treasury.gov/system/files/131/WP-118.pdf 
[https://perma.cc/K2QN-ZPEY]. 

287 See DEP’T OF THE TREAS., GEN. EXPLANATIONS OF THE ADMIN.’S FISCAL 
YEAR 2022 REVENUE PROPOSALS (May 2021), 
https://home.treasury.gov/system/files/131/General-Explanations-
FY2022.pdf [https://perma.cc/A383-254A]. 

288 See Main Street Tax Certainty Act, H.R. 4721, 118th Cong. § 2 
(2023); Main Street Tax Certainty Act, S. 1706, 118th Cong. § 2 (2023); see 
generally GARY GUENTHER, CONG. RSCH. SERV., REP. NO. IN12226, THE 
DEBATE OVER EXTENDING THE SECTION 199A DEDUCTION FOR QUALIFIED 
BUSINESS INCOME 1 (2024) (“There is bipartisan support in Congress for 
extending the Section 199A deduction beyond 2025.”), 
https://crsreports.congress.gov/product/pdf/IN/IN12226. 

289 See Rebecca M. Kysar, Lasting Legislation, 159 U. PENN. L. REV. 
1007, 1016 (2011). A historical example is the credit for research and 
development in § 41, which became permanent in 2015. See GARY 
GUENTHER, CONG. RSCH. SERV., REP. NO. RL31181, FEDERAL RESEARCH TAX 
CREDIT: CURRENT LAW AND POLICY ISSUES 3–4 (2022), 
https://crsreports.congress.gov/product/pdf/RL/RL31181. Current examples 
include a bevy of renewable and alternative energy credits. See, e.g., I.R.C. 
§ 25C. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 707 

administration passed similar time-limited tax cuts through 
the budget reconciliation process. In 2012 (and after a 
protracted, acrimonious political battle with Republicans), 
President Obama ultimately made a substantial portion of 
these tax cuts permanent.290 This history indicates that the 
pass-through deduction’s statutory expiration date should be 
viewed as a form of agenda-setting for future Congresses, 
rather than a statement of substantive policy.291 

The pass-through deduction’s long-term political economy 
also may prove difficult for any strategy that relies on the 
provision’s repeal or lapse. Section 199A applies broadly 
across the income spectrum.292 Since 2018, tens of millions of 
taxpayers have claimed deductions under § 199A, and the 
Office of Tax Analysis estimates that more than 80% of 
potential claimants fall outside of the highest income decile.293 
These potential voters may resist the expiration of an existing 
tax preference, even if their individual benefit is small 
compared to the dollar reductions claimed by high earners.294 
Moreover, the highest income decile receives more than 80% 

 
290 See Chye-Ching Huang, Budget Deal Makes Permanent 82% of 

President Bush’s Tax Cuts, CTR. ON BUDGET & POL’Y PRIORITIES, Jan. 3, 2013, 
https://www.cbpp.org/research/budget-deal-makes-permanent-82-percent-
of-president-bushs-tax-cuts. 

291 See Gersen, supra note 284, at 266 (2007) (“Statutory expirations 
constrain the discretion of committee chairs by mandating that certain items be 
placed on the committee’s agenda.”). 

292 See Krista M. Jones-May, Real People, Real Incomes: How New 
§ 199A (the New Twenty-Percent Deduction) Can Help Individuals in Lower 
Income Brackets, 18 APPALACHIAN J. L. 61 (2019) (arguing that § 199A 
operates in a straightforward manner for middle- and lower-income 
claimants); Andrew L. Snyder, Note, The Lawyer, the Engineer, and the 
Gigger: § 199A Framed as an Equitable Deduction for Middle-Class 
Business Owners and Gig Economy Workers, 25 FORDHAM J. CORP. & FIN. L. 
634–35 (“[R]epealing the provision would deny an equitable deduction to 
middle-class business owners and [independent contractors]—particularly, 
those working within the gig economy.”). 

293 See Goodman et al., supra note 286, at 16. 
294 Cf. Ventry, supra note 19, at 233–34 (“[A] near-unanimity of 

Americans still considered [the HMID] the key to homeownership even 
though a mere one-fourth reaped its benefits.”). 



  

708 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

of the deduction’s benefits by dollar value.295 This politically 
powerful cohort also may advocate in favor of extension or 
permanence.296 The result is political pressure for retention 
from both ends of the income spectrum. Finally, § 199A’s 
sunset falls after the 2024 presidential election, and unified 
Republican control of Congress and the Presidency strongly 
indicates that the provision will be renewed.297 Any repeal 
effort presumably would need to wait years and address any 
legislative changes in the extension process; substantive 
reform, however, may occur intentionally or organically as 
Congress extends § 199A beyond 2026. 

Substantive reform raises challenging conceptual and 
pragmatic issues in the § 199A context. As an initial matter, 
the underlying policy rationale for the pass-through 
deduction—in any form—is relatively obscure. Lawmakers 
clearly intended § 199A to compensate noncorporate 
businesses that did not benefit from the TCJA’s fourteen-point 
corporate tax rate reduction from 35% to 21%.298 From this 
perspective, the pass-through deduction provides some 
measure of equivalence in the effective tax rates for corporate 
 

295 Approximately $28 billion of $35 billion in total tax savings inure to 
the top income decile. See Goodman et al., supra note 286, at 16 (simulating 
tax savings by income deciles with “guardrails” under § 199A). 

296 See Shu-Yi Oei & Leigh Osofsky, Legislation and Comment: The 
Making of the § 199A Regulations, 69 EMORY L. J. 209, 234–36 (2019) 
(discussing interest group influence in the regulatory process for § 199A). 
President Biden’s campaign position to limit § 199A’s availability to high-
income claimants may reflect these constituency effects. See Understanding 
Joe Biden’s 2020 Tax Plan, COMM. FOR A RESPONSIBLE FED. BUDGET 4 (2020), 
https://www.crfb.org/sites/default/files/managed/media-documents2022-
02/CRFB%20USBW%20Biden%20Tax%20Plan%20Analysis_FINAL%20D
RAFT_07302020.pdf [https://perma.cc/6A6U-YFWL]. Moreover, the 
application of § 199A to REIT dividends and PTP income may draw 
additional—and powerful—interest groups into any reform efforts. 

297 See Erica York, Donald Trump Tax Plan Ideas: Details & Analysis, 
TAX FOUND. (Sept. 10, 2024), 
https://taxfoundation.org/research/all/federal/donald-trump-tax-plan-2024 
[https://perma.cc/8CZ7-DDW3]. 

298 See STAFF OF J. COMM. ON TAX’N, 115TH CONG., GENERAL EXPLANATION 
OF PUBLIC LAW 115-97, at 20 (Comm. Print 2018) (attempting to “[t]reat[] 
corporate and noncorporate business income more similarly to each other”). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 709 

and noncorporate business activities.299 The policy stakes 
involve choice-of-entity decisions for active businesses that 
are not publicly traded.300 But if Congress intended to improve 
efficiency by making taxpayers indifferent between corporate 
and noncorporate vehicles, or by simplifying choice-of-entity 
analysis for tax purposes, the pass-through deduction failed 
miserably.301 Alternatively, Congress may have intended to 
maintain the pre-TCJA presumption in favor of pass-through 
entities, though the reasons for preserving this presumption 
are dubious.302 Any substantive reform takes a position, 
explicit or implicit, on these issues. 

Furthermore, many of the pass-through deduction’s 
deficiencies arise from intrinsic problems in separating 
returns to labor and capital when a single taxpayer provides 
both.303 Section 199A’s elaborate restrictions and guardrails 
arguably attempt to draw this distinction—ineffectively, in 
 

299 See Michael S. Knoll, The TCJA and the Questionable Incentive to 
Incorporate, 162 TAX NOTES 977, 981 (2019) (finding claims that “top-bracket 
taxpayers” have an incentive to incorporate after the TCJA to be “largely 
incorrect”). 

300 See I.R.C. § 7704(a). 
301 See Bradley T. Borden, Income-Based Effective Tax Rates and Choice-

of-Entity Considerations Under the 2017 Tax Act, 71 NAT’L TAX J. 613, 614–
15 (2018) (“[C]hoice-of-entity decisions are more nuanced under the 
TCJA.”). 

302 One possible justification is that disrupting choice-of-entity decisions 
impinges on reliance interests and imposes inappropriate transition costs. 
From this perspective, § 199A compensates owners of pass-through 
businesses for their expectations about their relative contributions to 
federal income tax revenue. Compare David M. Hasen, Legal Transitions 
and the Problem of Reliance, 1 COLUM. J. TAX L. 120, 172 (2010) (critiquing 
the “new view” of legal transitions, which favors uncompensated 
transitions), with Graetz, supra note 155, at 87 (disfavoring grandfathering 
as relief from retroactivity). Alternatively, § 199A can be viewed as a 
concession to stability in choice-of-entity decisions in light of uncertainty 
about future corporate tax rates. See Knoll, supra note 299, at 977–78 
(arguing against “the general claim” that the TCJA would spur “a mass 
conversion of passthrough entities into C corporations”). 

303 See Lily Kahng, Who Owns Human Capital, 94 WASH. U. L. REV. 607, 
644 (2017) (“[T]he interdependent relationship between labor and capital . . . 
raises the question whether labor income and capital income can or should be 
viewed as separate.”). 



  

710 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

the view of many commentators.304 In part, the provision’s 
failings reflect the unorthodox processes through which the 
provision was enacted and regulations were promulgated.305 
But some of the provision’s challenges are conceptual. Tax 
gaming plays a role, as taxpayers seek to convert ordinary 
income (typically labor income) into income subject to a lower 
rate or other preference (typically capital income).306 Indeed, 
conversion strategies are endemic in tax systems that treat 
labor income and capital income differently.307 

 
304 See e.g., David Kamin et al., supra note 255, at 1460–61 (“The heart 

of the problem is the absence of a policy justification for many rules 
governing the deduction.”). Another problematic area involves rental real 
estate, where the issue is whether income reflects business returns, for 
which § 199A deductions are available, or investment returns, for which no 
§ 199A deduction is available. An owner-operator must provide a sufficient 
level of services to qualify the activity as a business; then, all returns, even 
from those services, are QBI. Cf. Rev. Proc. 2019-38, 2019-42 I.R.B. 942, 
942. 

305 See Shaviro, supra note 255, at 49–51 (2018) (“The pass-through rules 
stand front and centre in illustrating both the [TCJA’s] sloppiness and its 
lack of principle.”); see also Oei & Osofsky, supra note 296, at 211–13 
(describing Treasury’s relatively unorthodox approach to rulemaking when 
faced with a provision enacted “at warp speed”). An appropriate contrast is 
the (largely successful) legislative and regulatory processes surrounding the 
passive activity loss rules in § 469. See George K. Yin, Getting Serious About 
Corporate Tax Shelters: Taking a Lesson from History, 54 SMU L. REV. 209, 
218–19 (2001) (describing § 469 as an “outcomes-oriented” provision that 
does not look to purpose or intent). 

306 See David Gamage, The Case for Taxing (All of) Labor Income, 
Consumption, Capital Income, and Wealth, 68 TAX L. REV. 355, 404–05 
(2015) (arguing for taxing multiple tax bases as a response to conversion 
strategies); Mark P. Gergen, How to Tax Capital, 70 TAX L. REV. 1, 66 (2016) 
(describing how conversion strategies may implicate valuation issues); 
David A. Weisbach, A Partial Mark-to-Market Tax System, 53 TAX L. REV. 
95, 123 n.79 (1999) (describing how a partial mark-to-market regime would 
curtail conversion incentives). 

307 See Richard M. Bird & Eric M. Zolt, Dual Income Taxation and 
Developing Countries, 1 COLUM. J. TAX L. 174, 187 (2010) (noting practical 
problems faced by tax systems that treat income from labor differently from 
income from capital); Edward D. Kleinbard, The Right Tax at the Right 
Time, 21 FLA. TAX REV. 208, 283 (2017) (outlining “a labor-capital income 
centrifuge” to separate income from each source). 



  

No. 2] TRANSFORMING TAX EXPENDITURES 711 

If the normative version of § 199A provides a tax benefit to 
returns to capital, identifying and implementing adequate 
restrictions and guardrails is a mammoth task, one that 
probably is not achievable without serious compromises with 
respect to simplicity and administrability. In addition, the 
historical aggregation of business tax law creates planning 
wedges that may be impossible to mitigate without large-scale 
reform of business taxation. For S corporations, optimization 
problems involving reasonable compensation exist as long as 
S corporation owners also can be employees.308 For 
partnerships, the practical continuum between guaranteed 
payments and risky distributive shares cannot be obviated or 
avoided by changes to § 199A.309 In each case, smarter 
restrictions and guardrails are not a viable solution to the 
current problems in § 199A. 

As implemented by Treasury, § 199A largely ignores the 
labor-capital distinction for sole proprietors.310 Sole 
proprietors often provide personal services and cash or 
property to their businesses and earn an aggregate return. 
Allocating this return to these businesses’ labor and capital 
components is difficult in the absence of an arm’s length 
referent—and this difficulty acts as an invitation to valuation-
based tax gaming.311 If the sole proprietor reinvests returns, 
the problem compounds. The business’s earnings may 
comprise returns to current-year labor, returns to initially 
invested capital, or returns to the reinvested earnings from 
prior years’ labor. Under current law, the pass-through 
deduction avoids these complexities by granting its benefit to 

 
308 See Sheridan, supra note 281, at 659–60 (describing planning 

strategies to meet “the two-sevenths inflection point” to maximize benefits 
under § 199A). Even formula-driven solutions are susceptible to tax gaming. 

309 See Sheridan, supra note 281, at 661–62 (arguing that “QBI can be 
more easily maximized in partnership form”). 

310 The exception is SSTBs for sole proprietors over the threshold 
amount. I.R.C. § 199A(d)(3). 

311 On the difficulties involved in the allocation of income components to 
labor and capital, see supra notes 306–307. 



  

712 COLUMBIA BUSINESS LAW REVIEW [Vol. 2024 

sole proprietors without regard to labor-capital distinctions.312 
This result favors taxpayers who structure their business 
activities as a sole proprietorship.313 To the extent that 
§ 199A’s restrictions and guardrails are intended to focus the 
provision’s benefit on returns to owner-provided capital, any 
reform proposal should account for the separability of labor 
and capital for sole proprietors. 

 
3. Transforming the Pass-Through Deduction 
 
If the prospects for § 199A’s repeal, reform, or sunset are 

dim, then base-rate transformation may represent a viable 
reform vehicle. This transformation would expand § 199A to 
apply to virtually all taxpayers, then adjust statutory rate 
brackets to address revenue and distributional concerns. For 
§ 199A, the central step in a base-rate transformation is to 
expand the provision’s application to labor income. This step 
could be accomplished by eliminating restrictions that apply 
to employees, reasonable compensation paid by S 
corporations, and guaranteed payments paid by partnerships. 
The SSTB restriction also could be removed. The wage-basis 
limitation, loss rules, and investment activity-business 
activity distinction could be retained or removed, depending 
on Congress’s policy goals. If these restrictions were retained, 
their penalty function would be starker, as measured against 
baseline rates. As long as the limitation on double benefits in 
§ 199A(a) remains in place, the transformed § 199A deduction 
 

312 Compensation that creates (or increases the magnitude of) negative 
QBI has complex spillover effects on any other QBI earned by Taxpayer B. 
See Treas. Reg. § 1.199A-1(d)(2)(iii) (netting negative and positive QBI and 
carrying forward overall negative QBI); see also I.R.S., Tax Cuts and Jobs 
Act, Provision 11011 Section 199A—Qualified Business Income Deduction 
FAQs, Q&A 22 (Sept. 14, 2024), https://www.irs.gov/newsroom/tax-cuts-
and-jobs-act-provision-11011-section-199a-qualified-business-income-
deduction-faqs [https://perma.cc/295J-Y743]. 

313 Sole proprietorships include businesses conducted by individuals 
though disregarded entities, such as single-member limited liability 
companies. I.R.S., Sole Proprietorships (last visited Sept. 26, 2024), 
https://www.irs.gov/businesses/small-businesses-self-employed/sole-
proprietorships [https://perma.cc/ACK5-2SXA]. 



  

No. 2] TRANSFORMING TAX EXPENDITURES 713 

should not overlap other tax preferences. These changes 
would relieve much of the pressure on § 199A to distinguish 
labor income and capital income, and they would reduce 
incentives for tax gaming along various margins, such as 
choice of entity and employee-independent contractor status. 
Even if imperfectly designed, a base-rate transformation 
would eliminate § 199A as an impediment to other desirable 
reforms.314 

 
CONCLUSION 

 
This Article introduces, develops, and illustrates a novel 

mechanism for tax expenditure reform: base-rate 
transformations. As a policy strategy, base-rate 
transformations offer potential advantages—and 
disadvantages—compared to conventional repeal or 
substantive reform. Without taking a normative position on 
tax expenditures generally, this Article uncovers another 
option for lawmakers interested in the reform of tax 
expenditures, a perennial topic among lawmakers and policy 
experts. 
 

 
314 See Glogower & Kamin, supra note 14, at 1570–71 (arguing that 

§ 199A’s “greater harm” may be “the way in which it constrains 
policymakers from raising revenue from the highest income taxpayers 
through future reforms”).