Tax Reform and 'Social Engineering'

December 16, 2005

The new issue of Economists' Voice (Volume 3, Issue 1) features several excellent articles on the current tax reform debate, including a lead essay from Edward Lazear and James Poterba of the President's Advisory Panel on Federal Tax Reform.

In it, Lazear and Poterba roundly denounce the idea of implementing social policy through the tax system—using credits, deduction and exemptions to encourage or punish behavior in markets—something that has become conventional wisdom in Washington in recent years:

The Panel concluded that an efficient tax system should remove distortions to the extent possible, and that “social engineering” through the tax code should be avoided when possible.

It is possible to argue that some activities should be encouraged by the tax system, either because they create social externalities or because there are other distortions in the economy that could be offset by appropriate tax remedies. Such arguments are usually difficult to support with empirical evidence, and they lead to special privileges and a myriad of tax breaks that are likely, on balance, to reduce the efficiency of the tax system.

Given the political process that determines the tax code, special provisions are likely to depend more on an interest group’s lobbying efforts than on careful estimates of social externalities or other considerations.

Read the full piece here.

Probably the single most important source of poorly designed tax policy is the idea that the tax system should serve as a system of penalties and benefits to guide markets toward policymakers' goals, rather than a system to raise revenue for necessary government programs while interfering with markets as little as possible.

Implementing social policy through the tax system—rather than direct spending programs which are more transparent and subject to democratic controls—is routinely defended in Washington policy circles, despite the fact that it is widely criticized by economists like Poterba and Lazear as a source of gratuitous complexity and inefficiency in the tax system, and is subject to wide abuse by rent-seeking interest groups.

Let's hope more tax policy professionals start taking the arguments of Profs. Poterba and Lazear seriously.

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