This paper develops an estimate of the welfare cost of tax preferenees, or "loop-holes," in the federal
individual income tax. Items given preferential treatment
are considered as a composite good with a distortion in its relative price due to
exclusion from taxation. In 1974, the welfare cost is estimated to be $7.9 billion,
or 6.7% of tax revenue. Most of this welfare cost is borne by the higher income
classes; and when this cost is considered to be part of the tax burden, the degree
of progressivity of the tax is increased. An estimate of the marginal welfare cost
of tax preferences is also developed.
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