Deficits and Tax Expenditures

2024 10 17

Jack Salmon has “an ongoing series of pieces that focus on individual tax expenditures that policymakers might consider eliminating or reforming to address America’s dire fiscal trajectory.”   

If we are serious about deficits as we should be [https://thomaslhutcheson.substack.com/p/austerity-sic-is-in-the-air]

tax expenditures are well worth looking at.  Specifically, Salmon makes a good case that the American Opportunity Tax Credit  (A LOTC) is so poorly targeted and subject to such poor administration leading to abuse, that it should be eliminated or severely cut back, probably just folded into the Pell Grants.

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The same cannot be said for the treatment of the Earned Income Tax Credit which is discussed as an incentive to work rather than mainly as a way of making the tax system more progressive.  In passing, Salmon does point out that as structured the EITC actually provides little incentive to single, low-income workers to increase their labor force participation and this suggest making the EITC more of a wage subsidy, which would be a better way of transferring income to low wage workers that a minimum wage or a Universal Basic Income

https://thomaslhutcheson.substack.com/p/ubi-after-all

https://thomaslhutcheson.substack.com/p/ubi-no

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The discussion of the (now limited) deductibility of state and local taxes (SALT) Is also flawed.  While limiting the deductibility raised some $125 billion per year in revenues, which is good, so would somewhat higher rates on the same high income who benefit from the SALT deduction.  which is more compatible taxing consumption over saving and investment.  SALT is not consumption and taxing SALT encourages no desirable behavioral change.  Eliminating or limiting SALT deductibility without making up the revenue with higher rates just reduces the deficit by singling out one (geographical) set of high income taxpayers.

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In contrast, Salmon has a good discussion of the Low-Income Housing Tax Credit (LIHTC).  Subsidizing supply of something primarily consumed by low-income people in general is not a good way to transfer income, more so in the case of low-income housing as additional administrative costs must be incurred to ensure that “low income” people benefit from the subsidy.  Housing vouchers are a much more straightforward way to subsidize housing costs for low-income people.  Of course, substituting vouchers for the LIHTC would not contribute to deficit reduction. 

OTOH, Salmon is probably mistaken in blaming LIHTC for crowding out private development as that is more the result of local government land use and building codes that make it difficult to build ANY KIND of housing.

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Salmon duly joins generations of economists in favoring elimination of the tax exemption of interest paid on state and local government bonds.  To the extent that the subsidy leads S&L governments to overinvest it is undesirable – although most observers seem to think that S&L governments invest _too little_ in street and road maintenance and adaption of public infrastructure to climate hazards. 

Salmon advances the self-cancelling argument that the benefit of the subsidy goes partially to high-income tax payers, but that would imply less “distortion” of investment decisions.  And if deductibility is favoring high-income taxpayers, this should be corrected by making the subsidy a partial tax credit rather than a deduction   

Salmon also believes that more state and municipal investment should be financed by taxes rather than borrowing and more privatized.  Salmon cites many European airports being privately owned but I’d not be surprised to find they receive some kind of subsidy, including preferential credit.  Even if more S&L infrastructure should be privatized, however, it has little to do with costs of S&L borrowing.

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Salmon is on strong grounds in his criticism of Energy Subsidies.

The whimsically named “Inflation Reduction Act” subsidies investment in plethora of net CO2 emissions reducing technologies but with little consideration of the cost.  In part this stems from the error of aiming the subsidy at the amount investment rather than the resulting net emission avoided.  Nevertheless, Salmon’s discussion completely misses why subsidies are needed in the first place: to (imperfectly) compensate firms for reducing net emissions, pending the adoption of comprehensive taxation of net CO2 emissions.  [The crocodile tears “Given the concentration of energy subsidies among large multinational corporations, it should come as no surprise that the distributional impact of “clean energy” subsidies is highly regressive—that is, benefiting a wealthy few at the expense of everyone else” are droll.]

Notwithstanding much good analysis, Salmon’s list of tax savings seems arbitrary, [Why not deductibility of tax-favored consumption rather than partial tax credits?  Why not preferential treatment of “capital” income?  Why not bumping up of capital gains basis of inherited assets?] not guided by an attempt to balance the economic cost and benefit of each tax expenditure.   

No, if we are serious about deficits as we should be, ensuring that deficits <= Σ(expenditures with NPV>0), we need to be looking at revenue specifically:

a) taxation of net CO2 emissions,

b) moving the progressive income tax toward a progressive consumption tax (that collects more than the present personal income tax and business income tax do), and

c) replacing the wage tax with a VAT that fully funds social insurance transfers — Social Security, Medicare, Medicaid, ACA subsidies, unemployment insurance and child allowance.  [See https://thomaslhutcheson.substack.com/p/socia-insurance-20]

Image prompt: a man looking perplexed as a conveyor belt empties golden dollar signs into a chasm.

[Standard bleg:  Although my style is know-it-all-ism, I do sometime entertain the thought that, here and there, I might be mistaken on some minor detail.  I would welcome comments on these views.]