Time for Election Day “Truce” on Tax Credits

November 7, 2006

Just in time for today’s elections, Michael Kinsley delivers a terrific and well-deserved salvo against every lawmaker’s favorite campaign promise in this morning’s Washington Post: the use of tax credits to reward political constituents. From the piece:

They promise to “modernize” the tax credit for research and development; to “expand and improve” the already ludicrously complex system of tax-deductible retirement accounts such as IRAs and 401(k) plans (and match “dollar-for-dollar” the first $1,000 a person puts in); and to provide a “100% tax credit for tuition up to $3,000.” They want a “broadband tax credit” for Internet access in “rural and underserved” areas.

They call for a 50 percent tax credit for employee health insurance paid for by small businesses, as their solution to the health-care crisis. Needless to say, they love the tax credit for ethanol production and want to expand it for local ethanol producers. And — my favorite — they want a tax credit to cover the administrative costs of encouraging employers “to offer their employees the option to convert their retirement plan into an annuity when they retire.” I don’t know what that last one is about, but I smell an interested party. It’s just not the kind of thing thought up by anyone who doesn’t have some skin in the game…

The problem with tax credits in general is that they never appear in the budget, so they never get the same scrutiny as direct spending, although their impact on the deficit is exactly the same. By definition, they cost more than whatever benefit they are intended to achieve, since no one is going to be induced to spend an extra dollar on, say, dance lessons (because some member of Congress has decided that it would be good for the country if more people knew how to dance) unless the subsidy is worth more than a dollar. (Full piece here.)

What’s wrong with tax credits? As Kinsley notes in the piece, tax credits—or what economists call “tax preferences”—are designed to single out particular groups and behaviors for special treatment under the tax code. While tax credits can sometimes be good policy, the vast majority of them are not. Most existing credits amount to little more than strategic vote-buying on the part of Members of Congress, who use tax preferences to reward the special pleading of industries and coalitions.

With the recent trend toward making tax credits refundable—that is, taxpayers who owe no taxes receive a refund check for the credit amount—the historically fine line between tax credits and outright spending programs has largely vanished. And since tax credits allow lawmakers to distribute federal largesse with far less public scrutiny than spending programs in the budget, they have become Congress’ tool of choice for rewarding politically favored groups and industries.

Unfortunately, every tax credit, deduction and exemption enacted by Congress further erodes the federal income tax base, forcing up tax rates on the politically unpopular groups that remain in the federal tax base. And as the number of Americans outside the federal tax base shrinks, it makes the job of enacting base-broadening and rate-reducing tax reform more difficult—something that should appeal to everyone who wants a more efficient tax system, regardless of whether they are a Democrat, Republican, or something else.


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