Think Twice on Tax Credits (Even Popular Ones)
November 14, 2006
Today, the Chairman and Ranking Member of the Senate Finance Committee have made an impassioned plea for Congress to renew the research and development tax credit. While this credit is very popular, as Chairman Grassley pointed out, we do question the wisdom of using the government’s source of revenue to pick winners and losers. The primary problem is that tax credits erode the tax base. As the tax base shrinks, lawmakers will attempt to make up the lost revenue by increasing tax rates–leading to higher rates for everyone. Some Democratic leaders, poised to take over Congress next year, have already begun to suggest that raising tax rates will be necessary to pay for “middle-class tax cuts.” But Tax Foundation studies have shown that tax rates are already twice as high as they otherwise would be if the tax base were not worn down with tax credits:
The current system requires six tax rates ranging from 10 percent to 35 percent to raise the $912 billion in federal individual income tax revenue expected in 2005. That amounts to an average tax rate of 19.5 percent. If all personal income were taxed instead, the same revenue could be raised with rates ranging from just 4 percent to 17 percent. That would amount to an average tax rate of just 9 percent—less than half the current effective rate.
Chairman Grassley is right: tax credits are popular. But sound tax policy requires rising above politically popular measures and instead allocating the public treasure wisely. There is no reason to support measures that provide short-term gain but ultimately damage the economy in the long term.