Markets in a Minute
Ranked: The Biggest U.S. Tax Breaks
This infographic is available as a poster.
This infographic is available as a poster.
Ranked: The Biggest U.S. Tax Breaks
When you go to file your taxes this year, you’ll likely be looking for ways to minimize your tax bill. Tax breaks like credits and deductions—also known as tax expenditures—could reduce what you owe. On the flip side, they also cost the government trillions of dollars in foregone revenue.
In this Markets in a Minute from New York Life Investments, we rank the top 25 tax breaks by their forecast revenue impact over the next 10 years on the U.S. government.
What Are Tax Expenditures?
Tax expenditures are provisions within federal tax laws that result in government revenue losses. They can apply to individuals and/or corporations, and include a variety of things:
- Special exclusions
- Exemptions
- Deductions
- Special credits
- Preferential tax rates
- Tax deferrals
These expenditures are required by law to be included in the federal budget, and can be viewed as an alternative to other policy options such as direct spending. It’s important to note that when the budget is developed, revenue loss estimates are based on the assumption that all other parts of the tax code remain unchanged.
Tax Breaks, Ranked by Government Revenue Losses
With this in mind, let’s take a look at which tax expenditures are the biggest. We have ranked them by how much they are projected to cost the U.S. government in lost revenue over the next 10 fiscal years.
| Provision | Projected Revenue Losses 2022-2031 |
|---|---|
| Exclusion of employer contributions for medical insurance and medical care | $3.0T |
| Exclusion of net imputed rental income | $1.7T |
| Lower tax rates on capital gains | $1.4T |
| Tax benefits of defined contribution employer plans | $1.4T |
| Deductions for charitable contributions (excl. education and health) | $890B |
| Tax benefits of defined benefit employer plans | $808B |
| Deductions for mortgage interest on owner-occupied homes | $798B |
| Deductions for nonbusiness state and local taxes | $761B |
| Step-up basis of capital gains at death | $576B |
| Capital gains exclusion on home sales | $542B |
| Child credit | $446B |
| Tax benefits of self-employed plans | $437B |
| Treatment of qualified dividends | $421B |
| Deductions for state and local property tax on owner-occupied homes | $384B |
| Reduced tax rate on active income of controlled foreign corporations | $367B |
| Exclusion of untaxed Social Security benefits | $357B |
| Exclusion of interest on public purpose state and local bonds | $345B |
| Tax benefits of individual retirement accounts | $288B |
| Credit for increasing research activities | $272B |
| 20% deduction to certain pass-through income | $261B |
| Deductions for medical expenses | $180B |
| Exclusion of life insurance death benefits | $160B |
| Exclusion of benefits and allowances to armed forces personnel | $157B |
| Deductions for charitable contributions (health) | $153B |
| Exclusion of veterans' death benefits and disability compensation | $141B |
By a long shot, excluding an employer’s medical contributions from an employee’s taxable income is the biggest tax break. Family premiums for employer-sponsored coverage have jumped 47% over the last decade, outpacing both wage growth (31%) and inflation (23%).
The lower tax rates on capital gains is also forecast to cost the government trillions in lost revenue. In fact, the Biden Administration had proposed to significantly increase the capital gains tax in order to fund their budget, though this change has not come to fruition.
Tax expenditures related to retirement plans are also costly for the government. Income exclusions and tax deferrals for defined contribution plans are expected to cost $1.4 trillion over the next decade, nearly double that of tax breaks for defined benefit plans. This reflects the long-term decline of defined benefit plans. In fact, only 20% of U.S. workers participate in a defined benefit plan, whereas 43% participate in a defined contribution plan.
The Perks of Home Ownership
Finally, many of the largest tax breaks benefit homeowners. The exclusion of net imputed rental income—the theoretical income a homeowner would receive if they rented their home—is the second largest tax break.
On their primary residence, homeowners also get a capital gains exclusion when they sell their home. However, this exclusion is capped and is not indexed to inflation. Home prices climbed 19% in 2021 according to the S&P/Case-Shiller U.S. National Home Price Index, effectively lowering the benefit of this tax break.
Finding Opportunity in Tax Expenditures
From credits to deductions, there are a number of tax breaks available to Americans. You can consider them when you are structuring an investment portfolio. For instance, if you hold assets with capital appreciation potential—like stocks—for at least a year, they are typically subject to a lower tax rate on their capital gains. Making contributions to a retirement plan will allow you to reduce your taxable income and defer taxes, subject to certain limits.
Of course, tax expenditures are in flux based on government policy at the time. By staying up to date on changes, investors can be poised to minimize their tax obligations and grow their wealth.
Markets in a Minute
Identifying Trends With the Relative Strength Index
When is the S&P 500 Index considered overbought or oversold? The relative strength index may offer some answers to identifying market trends.
This infographic is available as a poster.
Identifying Market Trends: The Relative Strength Index
What happens when the S&P 500 Index enters oversold territory? Does the market reverse, or continue on this trend?
A widely-used momentum indicator, the relative strength index (RSI) may offer some insight. The RSI is an indicator that may show when a stock or index is overbought or oversold during a specific period of time, indicating a potential buying opportunity.
This Markets in a Minute from New York Life Investments looks at the RSI of the S&P 500 Index over the last three decades to show how the market performed after different periods of overbought or oversold conditions
What is the Relative Strength Index?
The RSI measures the scale of price movements of a stock or index. In short, the RSI is used to calculate the average gains of a stock divided by the average losses over a certain time period. These are then tracked across a scale of 0 to 100. Broadly speaking, a stock is considered overbought if it reads 70 or above and it is considered oversold if it is 30 or below.
For example, when the S&P 500 Index has a RSI of 85, an investor may consider it overbought and sell their shares. Conversely, if the RSI hits 25, an investor may buy the S&P 500 thinking the market will bounce back.
The RSI is often used with other indicators to identify market trends.
The Relative Strength Index and S&P 500 Returns
Below, we show the 12-month returns of the S&P 500 Index after key ‘overbought’ or ‘oversold’ conditions in the market as indicated by the RSI:
| Date | RSI | Shiller PE Ratio* | S&P 500 Index 12-Month Return |
|---|---|---|---|
| Jul 15 2002 | 20 | 23 | 9.4% |
| Dec 4 2006 | 73 | 27 | 4.5% |
| Oct 13 2008 | 15 | 16 | 7.3% |
| Feb 7 2011 | 75 | 23 | 1.9% |
| May 13 2013 | 75 | 23 | 16.1% |
| Jan 8 2018 | 89 | 33 | -7.2% |
| Mar 16 2020 | 22 | 25 | 66.3% |
| May 3 2021 | 72 | 37 | 0.0% |
*Measured by the average inflation-adjusted earnings of the S&P over 10 years
As the above table shows, following each period of extremely oversold territory in the RSI, the S&P 500 Index had positive returns.
In fact, the S&P 500 Index had the strongest one-year returns following the COVID-19 crisis of March 2020, with over 66% 12-month returns. During the time of extreme fear, the RSI sank to deeply oversold territory before sharply rebounding.
Interestingly, following periods of extremely overbought conditions in the market there was a range of positive and negative performance. Most recently, before the peak of the last cycle in 2021, the S&P 500 Index spent roughly 9 months in ‘overbought’ territory before declining into 2022.
The Relative Strength Index in 2022
With the economy in uncertain territory, how does the RSI look today?
In early June, following a bleak consumer sentiment announcement, the RSI fell to 30, hovering on oversold territory. Since then, it has risen closer to 40 as consumer sentiment and perspectives on economic conditions have slightly improved.
However, whether or not the RSI will continue on this uptrend remains to be seen.
For the remainder of 2022, market sentiment, which may be shaped by the coming GDP and inflation figures, could push RSI into oversold territory once again. As a bright spot this may be good news—reinforcing a turning point in the market.
Markets in a Minute
Visualized: How Bonds Help Reduce Bear Market Risk
How have bonds historically performed during a bear market? How have different stock and bond allocations performed?
This infographic is available as a poster.
Visualized: How Bonds Help Reduce Bear Market Risk
Which tactics can investors use to reduce portfolio downside risk?
One time-tested method is allocating to bonds. Bonds have sheltered portfolio losses during bear markets thanks to the lower risk profile of bonds compared to stocks. Often, when stocks declined during market selloffs, safer assets like bonds tended to increase as the demand for stability grew.
This Markets in a Minute from New York Life Investments shows the performance of bonds and stocks during bear markets since World War II.
Bond Performance During Bear Markets
Bear markets are defined as a 20% or more decline in U.S. large cap stocks from peak to trough. Since World War II, bear markets have occurred less frequently than bull markets, with the U.S. stock market spending 29% in a bear market versus 71% in a bull market.
With this in mind, we show how a spectrum of portfolio asset allocations to stocks and bonds have performed over the last several bear markets.
- Stocks: represented by U.S. large cap stocks
- Bonds: represented by U.S. intermediate government bonds, which are issued with maturity dates between two and five years
| Allocation (Stock / Bond) | Average Drawdown | Average Time Until Recovery* |
|---|---|---|
| 100% / 0% | -34% | 3.3 years |
| 90% / 10% | -31% | 3.2 years |
| 80% / 20% | -28% | 2.9 years |
| 70% / 30% | -24% | 2.8 years |
| 60% / 40% | -20% | 2.5 years |
| 50% / 50% | -16% | 2.1 years |
| 40% / 60% | -11% | 1.2 years |
| 30% / 70% | -7% | 0.8 years |
| 20% / 80% | -4% | 0.8 years |
| 10% / 90% | -2% | 0.5 years |
| 0% / 100% | -1% | 0.2 years |
*Length of time until new all-time high
For a 100% stock portfolio, the average drawdown was -34%, with 3.3 years until recovery—the time it took to reach a new all-time high.
Comparatively, a portfolio entirely made up of bonds fell -1% on average during bear markets with a recovery time of just a few months.
Balanced Portfolios in Bear Markets
Looking closer, we show how adding bonds to a portfolio has cushioned portfolio losses over the following market downturns, sometimes by as much as 20 percentage points.
| Bear Market | 100% Stock Portfolio Max Drawdown | 60/40 Portfolio Max Drawdown |
|---|---|---|
| 2020 | -20% | -10% |
| 2008 | -51% | -30% |
| 2001 | -45% | -22% |
| 1988 | -30% | -17% |
| 1973 | -43% | -26% |
| 1969 | -29% | -18% |
| 1962 | -22% | -13% |
| 1947 | -22% | -13% |
A balanced 60/40 portfolio had a 20% average drawdown, recovering in 2.5 years. During the 2020 COVID-19 crash, for instance, a 60/40 portfolio fell almost 10% and fully recovered in six months. By contrast, a 100% stock portfolio declined nearly 20%.
In all of the above historical downturns, investors with a diversified portfolio have been better positioned in a bear market.
Building Portfolio Strength
Bonds have historically seen less volatility than stocks during tougher financial conditions. Typically, riskier assets like stocks have been more prone to market fluctuations than bonds.
To prepare for a bear market, investors can structure a portfolio that aligns with their risk tolerance. Over the long run, the diversification benefits of bonds have been fundamental to protecting portfolios and lowering risk.
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