The package of six tax increases that passed in the Budget Conference Committee this week includes two described as loophole closers. Who can argue against closing a loophole? Unfortunately, the two provisions proposed to be changed aren't loopholes.

A loophole is the ability to use a rule in an unintended way. It may be due to poor wording or an incomplete definition in the law. For example, assume a state has a lower property tax rate for agricultural land to help farmers. However, the definition of agricultural land is so broad that the owner of a residence on 10 acres just needs to plant 20 fruit trees to qualify for the tax break. That's a loophole because a flaw in the law enables the rule to be used in unintended ways.

The two “loopholes” proposed to be corrected in the Budget Committee proposal are the net operating loss carryover for corporations and the $294 dependent credit for individuals. Neither are loopholes because each is being correctly used as intended.

A business has a net operating loss (usually called “NOL”) in any tax year in which its deductible expenses are greater than its revenue. A business may have a NOL due to a bad year, a business cycle that is longer than a tax year, or it could be a sign that the business is failing. It is not unusual for an income tax law to provide some relief by allowing the business owner to use the NOL against positive taxable income in prior or future years.

Does an income tax law have to allow for a NOL to be used to reduce income in a good year? No. Typically the rule is provided for equitable reasons because tax laws require annual tax returns. If tax returns were instead filed every two years, some businesses would not have a NOL.

The NOL carryover rules in California are being used as intended. Thus, changing the rule to suspend the use of NOLs for three years is not closing a loophole.

The other “loophole” closer is to reduce the $294 dependent credit for individuals with adjusted gross income above $150,000. The dependent credit is greater than the personal credit of $94. It was raised a few years back to provide a greater benefit to families. The Budget Committee hasn't stated that high-income individuals have found a way to claim the credit without actually having a dependent. Thus, it is not closing a loophole, it is just cutting back on this tax break.

So, why might the loophole language have been used?

Arguably, if you're going to get rid of a tax break, calling it a loophole should make it easier. But this approach distracts from the real changes that are needed to our tax system. There are many special deductions, credits and exclusions in our income tax law. Some of these serve an important purpose such as measuring ability to pay or encouraging charitable contributions. But some have outlived their usefulness, are overly generous or are poorly targeted such that they benefit taxpayers who don't need assistance.

Periodic review of these tax provisions would be useful in improving our tax system and state budget. Such a review would uncover tax breaks that could appropriately be cut back. It might even uncover some true loopholes.