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? 


Quentin

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.

Mark B. Hanson

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!

Mike B

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.

gwadagibeht

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.

Joe J

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.

Judith

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?

LOL.

Jack

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.

James

"...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."

I would bet that few members of the top 1%, or indeed, anyone outside the bottom quintile (who may get an Earned Income Credit), actually GET anything. At most, the government TAKES less than it otherwise would.

This is just another face of the "Buffett Rule" lie: spinning the fact that the upper quintiles may pay lower total rates to make it seem that they're paying lower taxes, when in fact that lower rate is assessed on a much larger income, so the total paid is much greater.

Mike B

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?

Alex

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.

madking

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.

madking

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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Robert

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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caleb b

This article makes an implicit assumption that a tax break are the same as a tax subsidy. However, it omits Loss-Aversion. Humans do not react the same to receiving money as they do to avoiding losing money. Therefore, if we replaced all tax deductions with tax payments, we would dramatically change the way people would respond to them.

Also: I think the government should not socially engineer how we live through the tax code. Taxes should go to cover expenses, not to encourage me to buy a house or have kids.

Thomas

I assume that what Justin is proposing is a simple per capita levy that is then adjusted up or down based on the relevant features that the tax code takes into account. Set it based on the most recent year's per capita revenue and adjust from there. Obviously that's the only way this would work. Otherwise, you'd be treating anything less than 100% income taxation as some sort of expenditure, and that's obviously not right baseline. No, the right baseline is the one that shows that the fact that most people don't pay anything in taxes is a form of tax expenditure.

madking

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 me 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.

tim

Wouldn't it be more accurate to use percentiles to compare tax subsidies between income groups? Seems like comparing apples to oranges otherwise as some who makes 10k a year is obviously going to get less back than someone making 1 million a year.

ringo

Framing is indeed the issue. To "fix" the problem we need to get the framing right. Here's how:

First, eliminate all withholding arrangements, all deductions, all credits, all exemptions.

On the 15th of March annually every resident in the country gets an itemized bill from the federal government which shows the total spent by the gov, the per capita figure each item represents, and the adjusted amount as a percentage of the taxpayer's income. The total at the bottom always equals an pre-determined percentage of the tax payer's total. Everyone mails them check.

I think the form should also include a checkbox next to each line item which the taxpayer can use to express disapproval for this item in the next year's budget. It is probably too much to hope that it would be binding, but at least this information should be forwarded to congress to use in the next year's budget process.

This reframes the discussion in some very useful ways:

1. All your income belongs to you, but you have to pay something for governmental services.
2. The services are specific and clearly known.
3. The amount we are all paying for governmental services is the same percentage of our income, and that percentage is well known and can become the focus of public debate.
4. Any individual lobbying for a handout is going to have the size of that hand out both in absolute terms and in terms of the individual's share made very clearly public.

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aepxc

I have no love for the taxes-are-evil crowd, and even less for the idea of a complex system of tax deductions. I wish as much of them would be ended as possible. But I do not think that this is a valid argument to make in support of ending/limiting them.

1. A citizen creates or captures a certain amount of value.
2. The government (as a representative of the citizens) determines what part of that value said citizen must pay as a fee for living in society, and which part of that value was unfairly captured/failed to be captured as a result of externalities and other logistical inefficiencies.
3. The citizen pays that amount.
4. The government spends the money it has on maintaining services deemed desirable for the functioning of society, and transfers the inappropriately captured (the externality part) value to its proper owners.

The difference between 2. and 4. is fundamental, not one of framing.

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