Tax Deductions or Tax Expenditures?

(Photo: David Reber)

Chances are, you’re going to spend tonight finalizing your taxes, making sure that you ferret every last deduction. And probably pretty pleased to be getting these deductions; but when you dig in a bit deeper, you may not be so sure — at least that’s what Betsey Stevenson and I argue in our latest column.

In fact, tax breaks are no different from either government handouts, or federal mandates, whether evaluated in terms of your finances, the government’s finances, or incentives:

Instead of looking at all the breaks for mortgage interest, health care, retirement savings and so on as deductions, picture the government writing you a check for each item. This equivalence between tax deductions and government spending leads economists to call them “tax expenditures.” Reformers have hit on an even more pointed description: spending through the tax code.

The tax system is also equivalent to a collection of individual mandates, like the one in the Obama health-care law, with penalties for Americans who fail to buy insurance. For many people, that’s how our system works. You and your neighbor might have the same income, but if, unlike your neighbor, you fail to have a mortgage or buy as much health insurance, then you have to pay higher taxes. 

It’s hard to see how you could be against government spending or against mandates, yet for more tax breaks.  Yet that’s exactly the position of Grover Norquist, the czar of the anti-tax pledge. Behavioral economists would call this a framing effect.      

For instance, you might think the mortgage interest deduction is a good idea.  What if we changed the framing though, and made it an explicit government handout:

Would you support giving millionaires with mansions 25 times more than the typical family? That’s effectively what we do: Middle-class families get an average benefit from the mortgage interest deduction of $139, while families in the top 1 percent get $3,752.

The non-partisan Tax Policy Center has done some great work shining a statistical spotlight on these tax expenditures:

Taken together, individual income tax expenditures are the equivalent of sending $686 each year to those in the bottom fifth of the income distribution, $3,175 to those in the middle fifth, and $30,714 to those in the upper fifth. The average member of the top 1 percent gets nearly a quarter of a million dollars a year.

So how does such an unfair system continue?  It’s politics.

Unlike typical government spending, tax expenditures aren’t reauthorized each year by Congress, so they have immense staying power. Because they aren’t as visible as outright spending, they aren’t subject to the scrutiny of campaigns to pare back waste or assess effectiveness.

This seems crazy.  So Betsey and I have a simple policy proposal:

Let’s replace all tax expenditures with explicit subsidies — that is, with actual federal payments — so we can really see the costs and debate all spending programs on an equal footing. Doing so would help us answer crucial questions, such as whether we get more bang for our buck by subsidizing homeownership or by spending more on schools.

Here’s Betsey making exactly this point last Sunday, on MSNBC’s Up! With Chris Hayes

What do you think?  Is there any reason that this should be controversial? 

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  1. Quentin says:

    I’ve thought this for a long time. We should get rid of all deductions and the government should have to write a check for all of the things it deems worthy of financial support. I’m not even saying there aren’t things worthy of the government’s financial support, but we need to think about them as if we were writing a check rather than just playing games with the tax code. I would also take it one step further and say we should have a federal law requiring the same of all state and local governments (by constitutional amendment if necessary). If a local government thinks they need to pay a certain company to move its headquarters from somewhere else, they should be prepared to write a check for it and justify it to their constituents.

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  2. Mark B. Hanson says:

    No, no, no, no, no! To think this way assumes the government is entitled to everything each individual has, and it costs them (hence all of us) to give it back, or let us keep some of it. Taxes are a payment by us for government “services” – a sort of social contract.

    This blogpost talks about framing – no wonder that those who believe in limited government might not like your framing it as if all government limitations are expenses!

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    • Mike B says:

      The flaw in your argument is that the concept of tax expenditure does not assume Government is entitled to everything people have. The point is that two people, obligated to pay equal tax will end up paying unequal tax based on their individual spending decisions due to government tax policy. It’s a valid counter argument to say that ALL people should be paying less taxes so if you believe that then advocate eliminating tax breaks and lowering general rates more equally.

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  3. gwadagibeht says:

    Taking less of our money is not spending. You can call it what you want but I will not rename taxation as releasing my own money back to myself. Language is a powerful thing.

    I of course don’t disagree with one aspect of what you’re getting at: everyone likes to talk about making the tax code more fair and simple, until they realize how much more “fair and simple” their own taxes might be without popular deductions.

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  4. Joe J says:

    It only is equivalent, if you make the assumption that all of a taxpayers money belongs to the government, and they are just being generous by letting you keep some of it. Instead of the truer view of it being your money and they are taking some of it.

    LOL, With tax breaks of course people who pay more taxes benifit more from tax breaks. It is only fair. Next you will say a lower price for gas unfairly punishes people who walk to work since only drivers recieve benifits.

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    • Judith says:

      A lower price for gas does unfairly punish those who walk to work, when the lower price is a result of government subsidies. And that’s without even factoring in all the negative externalities associated with driving to work.

      You’ve not only fundamentally misunderstood the article, but the example you’ve provided with the intention of being absurd actually demonstrates the opposite point. Why should I indirectly pay so that you can have cheaper gas?


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      • Joe J says:

        Except nowhere did anyone claim it had to do with subsidies.

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      • Judith says:

        I claim that:

        But that’s actually not the point here. I say you’ve misunderstood the article because it has nothing to do with whose money it is in the first place. The point that the authors are trying to make is that a “tax expenditure”/”tax deduction” is equivalent in terms of outcomes (i.e. how much money you have and how much money the government has at the end of the day) to a federal mandate/government subsidy/government handout.

        The problem, as they see it, is that although these two things are equivalent in terms of outcomes, people see them differently emotionally, which prevents clear-headed decision-making.

        Your comment and others responding to this article with “but it’s our money!” ably illustrate the authors’ point.

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      • Joe J says:

        Well heres an unemotional way of looking at it. I’ve a great way of increasing revenues. We eliminate the NEA. No I’m not cutting anything, I’m increasing revenues. You are just against it because you don’t see it clearly, that eliminating the NEA = increasing revenues.

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      • Kyle says:

        Actually, the argument about cutting the NEA being a revenue increase is completely correct. Increasing revenue by taxing the NEA’s budget at 100% and decreasing spending by giving the NEA $0 in budget both have the same outcome.

        I’m glad that you’ve realized what a powerful effect framing can have.

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    • m.m. says:

      Mark and Joe are wrong. No one is saying the govt. is entitled to ALL of your money. Rather, the govt. is entitled to reasonable contributions from its citizens. We decided that a percentage of annual income was a good way of doing this. So, just make it explicit that you give the govt. the 15% or whatever of your income that you’re required to, and then, should the govt. want to favor certain things (homeownership; marriage; children; education), it can simply cut you a check after it has processed your tax return. Pretty straightforward.

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  5. Jack says:

    Agree with Mark and Joe above. Who does the money belong to in the first place?

    That said, tax deductions should be drastically reduced (perhaps abolished altogether) and the rates simplified and cut; the federal government has no business using the tax code to manipulate people’s behavior.

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  6. James says:

    Hidden due to low comment rating. Click here to see.

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    • Mike B says:

      The laws of marginal utility is why the wealthy need to pay higher RATES, not just higher amounts. If I have 10 pizzas an additional pizza is worth less to me than if I only had 1 pizza or one piece of pizza. Under an EQUAL BURDEN tax code all citizens should feel the weight of taxes equally. Do you really think a billionaire will feel the sting of 20% of their income the same way someone living from hand to mouth would?

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      • James says:

        Hidden due to low comment rating. Click here to see.

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      • Joe J says:

        Ah fairness a word which has gotten mangled to mean such oddball things.
        Not only does it supposidly, no longer mean that everyone pas the same.
        no longer that everyone pays the same for the same benifit,
        it no longer means those who have more pay more,
        it apparently to some we have to screw it to others because we are jealous of their sucess. Which we will later redefine as having somehow been evil or cheating as soon as we decide how best to spin it.

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      • Mike B says:

        At the end of the ALL that matters is that I have an equal ability to pick up a gun and shoot a billionaire in the head as he does to shoot me. You can go on and on about what is moral and what is fair and what is theft and who is being jealous but if push were to come to shove all that really matters is physical force. All “Western Democracy” has done is to form a social contract where in actual physical violence is substituted for majority rule expressed through elected officials. As soon as the majority finds themselves less well off due to the actions of a minority it is that majority’s prerogative to rectify the situation.

        I think James made a great suggestion that people should pay into the system what they get out of it. What is it worth to a Billionaire to have an angry mob NOT shot up at their house and take all their stuff? I think it’s worth a hell of a lot more than they are currently paying. If you are destitute you get very little out of police protection because you have nothing to protect.

        There’s a clear balance here. Respect for property rights benefit rich and poor alike and elimination of all equality would not only be impossible to achieve, but would destroy much of what enables a society of human beings to function. On the other hand if you have large proportions of the population that are starving and have no means by which they can better their own situation or that of their children what do you expect them to do? Sit around and die?

        Progressive taxation not only makes sense from a marginal utility point of view, and from a benefit point of view, but also from just a long term self-interest point of view. Remember it was Henry Ford who realized that paying his employees enough so that they could afford to buy the cars he was making was a winning business decision. Public investments in infrastructure and education and even just the incomes who spend most of their income expands the pot of wealthy and further aids those who started with more at the beginning of the cycle.

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  7. Alex says:

    As the two above me allude to, it’s framing only relative to what taxes you were paying before you got the ‘deduction’ or ‘expenditure.’ So the question is, how do you argue for it being called spending if you take a hypothetical example of the implementation of a taxing government upon a previously untaxed people?

    Pretty much everyone would agree that the government is entitled to some of your money. The real issue that settles the ‘tax versus spending’ framing question is defining the baseline of how much of your money you think the government is entitled to.

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    • madking says:

      It has nothing to do with who the money belongs to in the first place.

      To keep numbers round, let’s assume my marginal tax rate is 25%. I’m renting an apartment for $1,000/month. I choose to buy a house, and my mortgage costs $1,000/month, with $900 of that being interest. Under the current system, my taxes go down by $2,700 per year. Under Betsey’s proposal, my tax wouldn’t change when I bought a house, but instead Uncle Sam would send my a check for $2,700 / year for buying a house.

      The net result is 100% identical to everyone involved. However, one system is much more politically palatable than the other.

      [WORDPRESS HASHCASH] The poster sent us ‘0 which is not a hashcash value.

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      • madking says:

        My next door neighbor (madknave), also pays $1,000/month rent. He buys the house next to my new house for the same price and the same mortgage. However, he earns less than me, so in our progressive tax system, his marginal rate is 15%. This means the government only reduces his taxes by $1,620 per year / sends him a check for that amount.

        As a tax deduction this can be spun, “madking pays more in taxes, so he gets more of a break than madknave”. As a government expense, this could be spun, “madking makes more money, so the government gives him more money to buy a house”

        I think most people would agree that it isn’t right or fair for the government to subsidize my house more than madknave’s house, just because I make more money.

        Counter argument:

        Is the tax deduction “unfairness” just counterbalancing some of the “unfairness” of a progressive tax code?

        Counter – counter argument: Two wrongs don’t make a right. Either a progressive tax code is fair/right/best or it isn’t. Either subsidizing people to buy houses is fair/right/best or it isn’t. The fact that affluent people can currently use the latter policy to partially counteract the former policy is an injustice/brilliant/a good political compromise depending on your point of view.

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  8. Robert says:

    I wonder if the problem is not the context/framing but the fact that these deductions, credits and exclusions are not treated as temporary subsidies of various economic behavior. If the housing market needs a bit of priming, allow a mortgage deduction for a year or two to help offset some economic problem. But then stop the subsidy so that the market doesn’t assimilate the new norm of a mortgage deduction and people purchase homes based on real costs. The first-time homebuyer credit worked this way, perhaps not enough, but it did have some effect. Now it’s too late, the market already has the mortgage deduction priced in so that eliminating it will create a new crisis. The Fed is subsidizing banking with low interest rates but will stop as soon as it’s no longer needed – my fear is that, as with Japan, the banks will come to accept this as the new normal if it goes on too long, leaving no tools for future crises that arise before rates can be raised.

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    • ThatGuy says:

      Your idea works only if there is a prescient, omniscient, and benevolent guiding hand in charge of the tax code. Otherwise even your well-meaning intervention causes market distortions.

      If you think Congress is any of these things you need to be committed.

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      • Owen says:

        First, define “market distortion.” Next explain a market that does not have “market distortion.”

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