Our tax code right now is, simply put, a mess. At 73,954 pages, the 2013 tax code is a monstrosity of loopholes, central planning, and giveaways for the well connected. We have ‘tax expenditures’ (ie special deductions) for those who: are married, own private jets, and operate race tracks (Yes, NASCAR gets $20 million/yr in industry-specific tax exemptions).
This is not to say that tax expenditures are pure crony capitalism. After all, your loophole is my well-earned tax break. Many of the larger expenditures—like the mortgage interest rate deduction—were put in place with the best of intentions.
Nonetheless, we should radically simplify the tax code by eliminating tax expenditures. All of them.
Let me point out that this is not a new idea. The FAIR Tax repeals all 73,000 pages of the tax code in favor of a single 23% sales tax. Americans for Tax Reform proposes a single flat income tax. Next week, I’ll be laying out my own proposal for a revenue-neutral tax code with no loopholes.
It’s important to note that none of these proposals mean more federal revenue; they’re deliberately designed to be revenue-neutral. Tax expenditures come out to $1.3 trillion per year, and economists on both sides agree that taking that much money out of the economy would be suicide. Moreover, even prominent Keynesians recognize that raising taxes during a recession is a bad idea.
But for now, let’s just focus on the case for eliminating tax expenditures.
First, there’s the economic cost of compliance. With a tax code longer than a Stephen King novel, navigating it can take days even for professionals. You get a deduction if you have a child in college, but only if you make under a certain amount; and if you have capital gains income, but only if you do X and Y with it; and on and on.
The IRS says that compliance takes 6.1 billion man-hours annually. That’s 3 million people working full time for a year, just on taxes.
To look at this another way, we spent around $163 billion on the tax compliance industry. That was back in 2008. Admittedly, that’s a pretty rough estimate, because it includes a percentage of the economic cost of record-keeping, and some of the record-keeping you take advantage of for your taxes is something you’d have to do anyway for another source. Still, the cost is enormous. Even if $163 billion is a high estimate (estimates vary widely, and it could as easily be a low one), the federal government’s massive tax code created so many problems that a $100-billion-plus industry emerged to fix it.
Of course, not all expenditures are boondoggles. For instance, the largest expenditure is the exclusion for employer-sponsored health insurance. It saves businesses $177 billion annually and gives a lot of people access to health care. The charitable contribution tax deduction saves charitable citizens $43.9 billion annually and promotes giving.
However, for every ‘good’ loophole, there are a dozen that are either poorly thought out or the work of special interest lobbying. And all combined, the system is tremendously expensive.
If we eliminate tax expenditures, some tax attorneys (at H&R Block, and also at the IRS) will be out of work. But they’re talented people with advanced degrees, and most of them will find work with different businesses. But in return, we’ll save the country $163 billion. Per year. That’s more money businesses can use to hire workers. More money you can use for car repairs or a family trip instead of paying a tax attorney. If you do your taxes at home, a simpler tax code will mean less time filling out Form 41-C and more time to play with your kids.
Those with more complicated taxes will benefit more from reform. But everyone who’s ever had to file taxes—including plenty of small businesses—will still win.
The second case for eliminating expenditures is crony capitalism. There are plenty of ways Congressmen can dole out special favors to lobbyists, but tax expenditures are one of the big ones. If you own a private jet, for instance, you get a tax break. This comes out to $300 million per year. NASCAR owners get $40 million per year in special tax breaks. In the fiscal cliff deal, the railroad industry got $165 million in tax credits and Goldmann Sachs made their new headquarters tax-exempt.
More broadly, corporations receive $121 billion in tax expenditures per year. And, as a rule, the bigger you are the more you save, because you can hire lobbyists to write the rules and tax attorneys to navigate them. What we have is essentially subsidies for large corporations by a different name. Admittedly, these tax breaks help keep people employed and promote lower prices. But they also raise barriers of entry and keep bad companies in business. Many smaller businesses have a hard enough time competing for customers without the state throwing its weight behind major corporations.
To be fair, some tax expenditures help small businesses. For instance, start-ups can deduct $5,000 of their first-year costs. But these benefits to smaller companies pale beside the handouts we give to larger corporations.
Tax expenditures that go to businesses rarely help the little guy. By aiding large corporations, we’re raising barriers of entry and stifling competition. It’s time we stopped.
You can make a similar case against many individual tax expenditures: regardless of their good intentions, they help those already at the top. The Home Mortgage Interest Deduction (MID), for instance, is intended to help middle-class folks buy a house. However, the reality of this deduction is a little different. Only 22% of Home Mortgage Interest Deduction (MID) benefits go to households making less than $100,000 per year. Households making $40,000 to $75,000 only receive $523 average from the deduction; families making $250,000 or more make 10 times that.
But the real tragedy for deductions like the MID is that they raise prices. The National Association of Realtors argues that reducing the MID would lower home prices by 15%. So what we have is a system that drives up costs, hurts every home buyer, and that then helps those at the top with large deductions. Because the system drives up costs, it ends up costing a lot of less wealthy home buyers more than it saves them.
The MID definitely helps some middle- or lower-class homeowners; let’s not paint this as black-and-white. If you’re lucky, MID deductions might help you more than MID-induced higher prices hurt you. But mostly, the MID benefits the housing industry and wealthy homeowners.
And this is, sadly, the case with most tax expenditures. Even the well-intentioned ones can hurt those they’re intended to help, through the law of unintended consequences.
This brings us to the third reason for reform: even well-meaning tax expenditures have unseen economic consequences. This is a large subject, and impossible to cover in one blog. In brief, however, when government pushes you to do X instead of Y, it distorts the free market. Government picks winners and losers by subsidizing some. Even for those like Jon Stewart who claim government does a great job of this, the issue is a moral one: freedom of choice. Consumers should be picking winners and losers, voting with our dollars for the companies that best serve us and the world at large. Governments, often victims of lobbying and backroom deals, should not be making our choices for us.
There are some tax expenditures that are well-intentioned and help those they’re intended to help. For instance, the tax deduction for charitable contributions saves people money and encourages giving. More importantly, there’s not really a charitable ‘market’ to distort; unlike the MID or many similar deductions, this one can’t drive up prices. An argument could be made for keeping one or two deductions, but the problem with this is that it becomes a slippery slope. I want to put my deduction in, so I let you put yours in as well, and then we let Congressman James put his in so that he’ll vote for the overall package, etc. It’s easier and simpler to cut all tax expenditures.
Tax expenditures are not all bad: they’re not all crony capitalism or loopholes. Your ‘loophole’, after all, is my well-earned tax break. They save real people real money. Sometimes they even help those they’re intended to. But tax expenditures as a whole promote central planning and often help special interests or those with money to pay. Even the ones that are well-intentioned, like the MID, often hurt those they’re intended to help.
So let’s reform the tax code. Not to raise new revenue; economists on both sides agree that you shouldn’t raise taxes in a recession. Let’s reform to create a leaner, simpler system. A system that promotes fairness instead of crony capitalism.
Next week, I’ll delve more into different ways of changing the tax code, including my own proposal. But for now: the tax code is a monstrosity. Let’s change it.
If you’d like to get involved with this issue or learn more, here’s how:
To learn more about crony capitalism (of which tax expenditures are a big component): Against Crony Capitalism
To learn about economists who support a more even tax: Friedrich Hayek Society
To learn how crony capitalism differs from real capitalism: Crony Capitalism = Phone Capitalism
To learn about the FAIR Tax (currently the most popular alternative to our system): FAIRTax
All four of these are great sites. They offer the opportunity to learn more, but also to get involved politically and turn thought into action. While I cannot endorse everything they say or might say, I’m very glad to receive regular updates and information from all four.