Rethinking Veterans’ Tax Benefits

May 25, 2008

With Memorial Day approaching, it’s a good time to think about the tax treatment of veterans. While criticizing any policy that expands benefits to those who serve in the military is not likely to be very popular on the surface, policymakers and the general public who truly believe that it is in our country’s interest to compensate those who serve in the military need to realize that the tax code is not always the best vehicle for doing so.

The federal tax code is filled with many caveats, with its numerous and complex deductions, exclusions, credits, multiple rates, and more, which means that using it to implement social policy can be very difficult. Part of the complexity lies in the way the tax code treats different individuals differently, including veterans who receive special tax treatment.

The typical justification for veterans’ receiving special treatment in tax policy is that we are thanking them for their service (and increasing the compensation of future military servicemen and servicewomen). But using the tax code can give one veteran a much larger benefit than another veteran—for example, a high-income veteran compared to a low-income veteran. In 2006 during his run for the Senate, Virginia Sen. Jim Webb proposed cutting federal income taxes for veterans, which would have resulted in a larger benefit for some veterans than for others. We commented on the proposal here. By using the tax code to provide veterans’ benefits, we are implicitly saying that one veteran’s service is worth more than another veteran’s service.

Politicians and the general public need to realize that the tax code is not always the best tool for achieving a social goal. While it may sound good for a policymaker to talk about “cutting taxes for veterans,” it would likely be more efficient and definitely more equitable (and even consistent with sound economic principles) to merely increase veterans’ benefits by the amount that the special tax break would cost.

Many state tax policies geared towards veterans have similar problems. For example, many localities have special tax rates on property for veterans. But this discriminates among veterans based upon the value of their homes and also whether they rent or own (depending on the economic incidence of the property tax). Why not just write each veteran a check? Other states have special income tax policies that provide generous tax treatment for veterans’ income. Once again, these are problematic given that government is implicitly saying that one veteran’s service is worth more than another given their tax/income profile.

Giving veterans tax breaks is certainly not the only way to reward them financially. If we truly want to thank veterans, we should think carefully about the different methods for doing so and choose the one that is most economically sound, most effective, and most equitable.

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