Tax Expenditures: Definition, Types, and OBBBA Changes

Tax expenditures are provisions in the federal tax code that let certain taxpayers or activities pay less than the baseline rules would require, through exclusions, exemptions, deductions, credits, preferential rates, or deferrals. Economists and budget analysts call them “expenditures” because the effect on the Treasury is the same as if the government collected the tax and then wrote a subsidy check. In fiscal year 2026, they cost an estimated $2.6 trillion, more than all annually appropriated discretionary spending combined, including defense.¹

Why Tax Breaks Count as Spending

The logic is straightforward. When the government lets you keep $1,000 through a tax break, the budget impact is identical to collecting that $1,000 and mailing you a subsidy check. Either way, the Treasury has $1,000 less to work with.

That equivalence is exactly what makes tax expenditures attractive to lawmakers. A new spending program requires an agency, a budget, annual reauthorization, and political fights over appropriations. A tax provision, once written into the code, runs on autopilot. It doesn’t face annual votes. It doesn’t show up as “government spending” in the headlines. And because it reduces what the IRS collects rather than what agencies distribute, Congress can support favored activities while maintaining the appearance of a smaller federal footprint.

The Statutory Definition

Federal law defines the term. Under the Congressional Budget and Impoundment Control Act of 1974, a tax expenditure is any “revenue loss attributable to provisions of the Federal tax laws which 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.”² Those six mechanisms are the whole universe. Every tax break in the code fits into one of them.

The Six Types

Each mechanism alters your tax bill differently. Two provisions worth the same dollar amount on paper can deliver very different benefits depending on your income, so the distinctions matter.

Exclusions

An exclusion keeps certain income from ever appearing on your tax return. The largest example: your employer’s contribution toward your health insurance premiums never counts as taxable wages. You receive something of real economic value, but the tax code treats it as if it doesn’t exist. Because the income is never counted, it escapes both income tax and payroll taxes.

Exemptions

An exemption removes a specific amount or category of income from taxation based on qualifying criteria. Tax-exempt bonds issued by state and local governments are a common example. The interest you earn is real income, but federal law exempts it entirely.

Deductions

A deduction subtracts a specific amount from your gross income before the tax rate applies. The mortgage interest deduction, for instance, lets homeowners who itemize subtract interest paid on up to $750,000 of home acquisition debt.³ The value depends on your bracket. A $10,000 deduction saves someone in the 37% bracket $3,700, but only $1,200 for someone in the 12% bracket. That makes deductions inherently more valuable to higher earners.

Credits

A credit reduces your tax bill dollar for dollar, regardless of your bracket. A $2,000 credit saves $2,000 whether you earn $40,000 or $400,000. Credits come in two varieties. A nonrefundable credit can reduce your tax bill to zero but no further. A refundable credit pays you the difference if the credit exceeds what you owe. Someone with $500 in tax liability and a $2,000 refundable credit would receive a $1,500 payment from the IRS.

Preferential Rates

Some income gets taxed at lower rates than ordinary wages. Long-term capital gains and qualified dividends face rates of 0%, 15%, or 20%, rather than the ordinary income rates that top out at 37%.⁴ The gap means a dollar of investment profit can be taxed at roughly half the rate of a dollar of wages.

Deferrals

A deferral doesn’t eliminate a tax. It postpones it. Traditional 401(k) and IRA contributions are the most common example. You skip taxes on the money going in, it grows untaxed for decades, and you pay income tax when you withdraw it in retirement. For 2026, employees can defer up to $24,500 through a 401(k).⁵ The government eventually collects, but the time value of the delay is substantial, and the revenue loss from retirement plan deferrals is among the largest in the code.

The Biggest Individual Provisions

The Treasury Department ranks every tax expenditure by its annual cost. For fiscal year 2026, the five most expensive individual provisions were:⁶

Employer-sponsored health insurance exclusion: $309 billion. This provision lets employers pay for coverage without that compensation counting as taxable income, making employer-provided insurance cheaper than buying the same coverage with after-tax wages.
Net imputed rental income exclusion: $185 billion. Homeowners who live in their own homes don’t pay tax on the rental value they effectively receive from themselves.
Defined contribution retirement plans: $181 billion. The tax deferral on 401(k)s, 403(b)s, and similar plans.
Capital gains preferential rates: $151 billion.
Defined benefit pension plans: $77 billion.

These five alone account for more than $900 billion. The list is dominated by health insurance, housing, and retirement, areas where Congress has decided the tax code should actively encourage specific behavior rather than simply collect revenue.

Other significant individual provisions include the child tax credit, which the One Big Beautiful Bill Act increased to $2,200 per qualifying child starting in 2025, indexed to inflation, and the standard deduction, which for 2026 stands at $16,100 for single filers and $32,200 for married couples filing jointly.⁷ The standard deduction is itself a tax expenditure, and because roughly 90% of filers now claim it instead of itemizing, many itemized deductions like mortgage interest reach far fewer taxpayers than people assume.

Corporate Tax Expenditures

The statutory corporate tax rate is 21%, but most corporations pay less because of provisions designed to encourage investment, research, and domestic production.

Bonus Depreciation

When a business buys equipment or other qualifying assets, it can write off the full cost immediately rather than spreading the deduction across the asset’s useful life. This 100% bonus depreciation was originally introduced by the 2017 Tax Cuts and Jobs Act and had been phasing down by 20 percentage points per year. The One Big Beautiful Bill Act, signed in July 2025, restored the full write-off and made it permanent for property acquired after January 19, 2025. Letting businesses deduct capital costs upfront reduces the effective tax burden on new investment.⁸

Research and Experimentation Credit

Companies that invest in developing new technology or improving existing products can claim a credit equal to 20% of qualified research expenses above a base amount.⁹ Unlike a deduction, it directly offsets the tax bill. The credit has been in the code since 1981, was made permanent in 2015, and the OBBBA restored immediate expensing for domestic research costs, which had been required to be amortized over five years starting in 2022.

Foreign-Derived Intangible Income Deduction

Domestic corporations that earn income from intellectual property used abroad can claim a deduction that effectively lowers the tax rate on that income well below 21%.¹⁰ The provision is meant to discourage companies from moving intellectual property offshore to low-tax jurisdictions.

Clean Energy Credits

The Inflation Reduction Act of 2022 created or expanded roughly two dozen energy-related tax credits for businesses investing in renewable energy, clean manufacturing, and carbon capture. The OBBBA significantly altered this area, phasing out or restricting several credits, notably repealing the clean electricity investment credit for wind and solar facilities placed in service after 2027, while expanding others such as raising the advanced manufacturing investment credit for semiconductor production from 25% to 35%.

The Overall Scale

The Congressional Budget Office estimates that all individual and corporate tax expenditures combined totaled $2.6 trillion in fiscal year 2026, or 8.0% of GDP.¹ For context, total discretionary spending, meaning everything Congress votes to fund each year including the entire defense budget, was projected at $1.9 trillion for the same period.

The ten largest tax expenditures alone were projected to exceed $1.4 trillion, accounting for nearly two-thirds of the total. Debates about “tax reform” are really debates about a handful of provisions, not thousands of obscure loopholes.

Who Benefits

Tax expenditures are not distributed evenly across income levels. A deduction’s value scales with your tax bracket. Preferential capital gains rates primarily benefit people with substantial investment portfolios. Exclusions like employer-sponsored health insurance deliver larger tax savings to employees in higher brackets.

A CBO study of the ten largest individual tax expenditures found that 17% of combined benefits flowed to households in the top 1% of income.¹¹ Credits, especially refundable ones like portions of the child tax credit and the earned income tax credit, are the main exception. Because their value doesn’t rise with income, and refundable credits can generate payments to people who owe no tax, they tend to direct more benefits toward lower- and middle-income households.

How the Government Tracks Them

The 1974 law that defined tax expenditures also required the government to quantify them. The Treasury Department publishes an annual tax expenditure budget as part of the President’s budget proposal, listing every provision and its estimated revenue cost. The Joint Committee on Taxation produces its own independent estimates.¹² The two sometimes differ because Treasury and JCT use slightly different baselines for what counts as “normal” tax treatment versus a special break.

What the OBBBA Changed

The tax expenditure landscape shifted substantially when the One Big Beautiful Bill Act became law on July 4, 2025. Many of the largest individual provisions had been set to expire at the end of 2025 under the TCJA’s original sunset. Without action, the top rate would have reverted to 39.6%, the standard deduction would have roughly halved, and the child tax credit would have dropped back to $1,000. The OBBBA made most of these provisions permanent and expanded several:

Individual tax rates: The 37% top rate is now permanent.⁷
Standard deduction: The expanded amount is permanent and indexed to inflation ($16,100 single, $32,200 joint for 2026).
Child tax credit: Increased to $2,200 per child and indexed to inflation, with tightened eligibility rules.
SALT deduction cap: Raised from $10,000 to $40,000 for taxpayers with income under $500,000 through 2029, then reverts permanently to $10,000.
Pass-through business deduction: The 20% deduction for qualified business income from partnerships, S corporations, and sole proprietorships is now permanent.
Bonus depreciation: Restored to 100% and made permanent for qualifying property acquired after January 19, 2025.
R&D expensing: Domestic research costs can again be deducted immediately rather than amortized over five years.

Each of these either created a new tax expenditure, expanded an existing one, or prevented a scheduled reduction. The combined cost will shape the federal budget for decades.

1
Congressional Budget Office. The Budget and Economic Outlook: 2026 to 2036
2
Office of the Law Revision Counsel. 2 USC 622 – Definitions
3
Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction
4
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
5
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
6
U.S. Department of the Treasury. Tax Expenditures Fiscal Year 2026
7
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
8
U.S. Bureau of Economic Analysis. How Do Changes in the Tax Treatment of Depreciation Impact NIPA Corporate Profits?
9
Office of the Law Revision Counsel. 26 USC 41 – Credit for Increasing Research Activities
10
Internal Revenue Service. IRC Section 250 Deduction – Foreign-Derived Intangible Income (FDII)
11
Congressional Budget Office. The Distribution of Major Tax Expenditures in the Individual Income Tax System
12
GovInfo. Tax Expenditures