Meet “Dirty Dozen” Tax Break #12: Exclusion of Fringe Benefits through Cafeteria Plans

Blog Post by: Benjamin Landy , on January 4, 2013

In 2002, The Century Foundation convened the Working Group on Tax Expenditures to examine and propose reforms to the tax code. The resulting report, Bad Breaks All Around, identifies twelve tax breaks with little or no economic justification. These "dirty dozen" are no less ripe for the chopping block a decade later, as Congress finally takes up the task of simplifying the tax code. Follow along at Blog of the Century and on the "Dirty Dozen" expenditures homepage as we reintroduce each of the "dirty dozen" and explain why it's long past time to eliminate these costly tax breaks.

If asked, most people would likely say that someone who pays cash for their life insurance or monthly parking expenses should not be asked to pay more than someone who gets fringe benefits through their employer. And yet, absent any organized political interest to counter this unfair treatment, employees covered by so-called "cafeteria plans" through their workplaces are allowed to withhold otherwise taxable income for eligible expenses. For the millions of Americans without these fringe benefits, expenses like meals, bus passes, and child care can cost up to 35 percent more, depending on the individual's marginal income tax rate.

"Tax policy analysts have long complained about the disparity between cash wages and benefits," write the authors of Bad Breaks All Around, The Century Foundation's 2002 report on tax expenditures. Even setting aside the question of economic fairness, there is the issue of market distortion: "Tax subsidies for certain kinds of spending may encourage it at the expense of otherwise more satisfying outlays." A tax break for employer-sponsored accident and disability insurance, for instance, may encourage a less efficient distribution of resources than the market would otherwise sustain.

Tax subsidies for employee compensation paid in fringe benefits cost the federal government billions of dollars each year in lost revenue. (The graph below highlights eight common tax-exempt employer-provided benefits, which together cost nearly $16 billion in 2012.) As the nation grapples with ways to simplify the tax code and reduce the deficit, policymakers should consider whether there are compelling reasons to subsidize certain consumer behaviors, and whether the billion-dollar price tag is justified.

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