Tax Credits and Subsidies
My former colleague Will Wilkinson offers some insightful comments on our intuitions regarding taxes, subsidies, and fiscal policy. To wit:
I think the assumption on the right is that first we work to make money on the market, and then later the government swoops in and takes a bite from the fruit of our labour. And that’s acceptable, up to a point. The government has important work to do. It needs money. And we all ought to pay our fair share. But government also does way too much. It is out of control. Taxing us to finance its illegitimate functions is exploitative and unjust. Since the government collects revenue far in excess of that required to pay for its limited, legitimate activities, most tax cuts amount to returning to the people what it is theirs by right. Refraining from stealing money isn’t a way of “spending”. Tax deductions and credits are best understood as selective restraint, as selective acknowledgement of what is ours, on the part of a generally kleptomaniacal government. The tax code isn’t riddled with “tax expenditures”. It just has an exceedingly complex schedule of more or less exploitative rates. Sure, homeowners with children pay less than childless apartment dwellers at the same income level. If some people are getting screwed over worse—having more of their income unjustly expropriated—that doesn’t mean that the government is “spending” money on those getting screwed over less.
This is a narrative I generally agree with. But Wilkinson offers an objection, drawing on Justin Wolfers and Betsey Stevenson (with whom I also often agree):
“You may feel very differently about tax deductions, government handouts and mandates backed by penalties”, Ms Stevenson and Mr Wolfers write. “Economically, though, they are identical.” So, yes: as far as economics is concerned, a tax credit and a government check of the same amount are indistinguishable. Yet, as far as common sense is concerned, giving and not taking are not indistinguishable. When government cuts a check, it comes out of a pool of money taken from other people. When it imposes a lower tax rate for homeowners, homeowners keep more of what they earned. To understand not taking as a way of giving seems to require that we assume government was entitled all along to what it did not take. This seems quite wrong.
There is a difference, however, between tax subsidies and subsidies subsidies.
Although economically a tax credit and a government check may be identical, they are not identical in their long-run political futures. Government doesn’t actually like issuing checks. It has a strong, long-demonstrated preference for vouchers, which are spendable on a single item or class of items. Why? Because when the government issues a voucher, it keeps more control over how your money gets spent. Governments like control, and as a result, your housing voucher can only buy some kinds of housing. (Which kinds? That’s for the political process to decide. As always.)
The government’s structure makes it eager to employ more administrators, who will attach more strings than can usually be managed through the tax code. When the strings are in the tax code, we tend to protest them. When they are pulled by bureaucrats, the bureaucrats think themselves important, and they applaud our wisdom whenever we give them more power.
Now, I don’t actually mean to be putting in a good word for deductions and penalties in the tax code. If it were up to me, there wouldn’t be any, not even for mortgage interest. And yes, I’d take a big personal hit from giving up that deduction. But if you like economic efficiency, and if your choices are “tax code” or “bureaucratic/legislative process,” the former is probably the better bet.