Tax Expenditures Can’t Exist

In most plans to reduce the deficit “tax expenditures” is a phrase that comes up often. We have to “reduce tax expenditures” or “get rid of spending in the tax code”. This is a popular way politicians try to sell their plans to eliminate credits and deductions that families or businesses count on when filing tax returns. The idea of reducing tax expenditures is central to the plans proposed by President Obama, the Senate Gang of Six, and the Simpson-Bowles debt commission. The popularity of this phrase and idea is nothing short of astounding, considering the fact that, in the real world, “tax expenditures” do not exist.

Furthermore, they can’t exist. The tax code is set-up to collect tax revenue from people and businesses. Eliminating the so-called tax expenditures alone is (and must be seen as) a tax increase. If the concept of tax expenditures is given serious intellectual credit the logical implication is that all money belongs to the government, and allowing someone to keep any portion of their personal income should be considered a government expenditure. A credit or deduction is not spending in any way. The Treasury never wrote anyone a check (with the exception of refundable tax credits, which are a special case) and it is not a federal outlay. When someone deducts something from their tax liability, less of their money goes to the government. The key here, that should be obvious, is that they have just kept more of their own money. This is true for deductions and to a much greater extent tax credits (as these are matched dollar for dollar in a decreased tax liability). Again, this should be elementary for everyone to understand: keeping more of one’s own money does not mean the government has spent anything. If a mugger passes you on the street and chooses not to rob you, it is not the same as him deciding to hand you some cash.

To the credit of Western Civilization, most people still see the truth and agree with the basic premise that tax expenditures should not be seen as spending. The Supreme Court recently decided that an Arizona tax credit did not count as spending by the government. Many scholars have also been critical of equating tax expenditures to government spending as well. Even Jon Stewart has called Obama’s efforts to cut “spending in the tax code” a type of Orwellian Newspeak. However, despite these opinions, a consensus is far from being reached on the issue. Many on the left still consider tax expenditures spending through the tax code and even some on the right are moving that direction. Even the Senate “Gang of Six” has departed from the world of logic and offered to help decrease “spending in the tax code.” This is a fight that will not be won easily but there are few fights, if any at all, that are more important.

Here is the truth about the so-called tax expenditures. First, they extremely distort the market. They create incentives for a certain industry or behavior over others. There is no argument from any side that can debate this fact. Two, that being acknowledged, they are still not spending. The government is allowing an individual or business to keep more money that was rightfully earned (even if it is for use on something specific). It is important to keep in mind that government spending of any kind is also distorting to the market as well. Three, tax expenditures are not fair. This is true but is not surprising. Our entire tax code is full of unfair provisions and taxes are by nature unfair. Grover Norquist remarked about taxation, “Taxation consists of taking money from people who earned it.  Fairness, my friend, does not enter the equation.  One can tax in more or less destructive ways. Fairness is an odd requirement to demand of the state's appropriation of our time, money and lives.” This leads into the most important and most basic tenant to keep in mind whenever tax expenditures are discussed.

The money that individuals (or businesses) make is rightfully their own. The government has no inherent claim to it and the theft of this income is a necessary evil to finance our society. This is paid in taxes all the time. There are valid complaints about the tax code and it is ultimately best to strive for a simple, low, flat, and fair rate that people pay with no deductions or credits of any kind. Until then however, money the government lets people keep is no way equivalent to the government spending money.