Making the Problem Worse: Credits, Credits, and More Credits

January 4, 2007

Brian Phillips

Brian Phillips

An editorial in today’s Florida Times-Union is a perfect example of the problems caused by the mucking up of the tax code with politically driven tax credits.

If two families live in different states but have similar size and financial situations, their federal tax bills should be the same.

Right?

Prior to 1986, according to Tallahassee-based Florida TaxWatch, people could deduct all of their state and local taxes in computing how much they owed the IRS.

Then, Congress eliminated the sales tax deduction. That created an inequity.

If someone lived in a state that relied heavily on an income tax, he got a bigger break on his federal taxes than those who lived in a state relying on sales taxes.

The argument isn’t exactly subtle: those guys got theirs, we want ours.

Now imagine a tax code that includes literally tens of thousands of similar “we want ours” tax carve-outs that benefit special interests and politically popular groups. Actually, there is no need to imagine because it’s exactly what we have: a complex web of credits that pick apart the tax code like vultures fighting for scraps. Instead of a rational process that raises revenue to pay for America’s priorities, we have an insane system that mitigates inequity with more inequity.

The insanity is fueling current American disillusionment, anxiety and frustration over our financial future. No matter how much we pay, we always think the other guy is getting a break. The feeling creates insecurity and instability for American families who are unsure how to accurately plan for future financial needs, such as retirement and college tuition.

The editorial goes on:

Congress recently took a step toward solving the problem – an inadequate one, unfortunately.

The bill, signed by the president last month, allows people to deduct sales taxes for 2006 and 2007.

That’s a start. Why not either make the sales tax deduction permanent or, as an alternative, do away with all deductions for state and local taxes?

Why not make the sales tax deduction permanent? Because it exacerbates bad tax policy and increases the perception of unfairness. It’s only a matter of time before some other group realizes that they aren’t getting the preferences that some have and the downward spiral continues. More carve-outs. More inequity. More tax breaks. More inequity. “We want ours!”

The system is broken and these political solutions only further its disintegration.

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

A tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state/local taxes paid, mortgage interest, and charitable contributions.

A sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.